Coverdell ESAs: a viable alternative to qualified tuition plans.

• Author: Packard, Pamela
• Position: Coverdell Education Savings Accounts

In planning their estates, tax-payers have been focusing on Sec. 529 and qualified tuition plans and the benefits donors and beneficiaries can reap. However, in 2002, law changes governing these accounts made the Coverdell Education Savings Account (ESA) an attractive alternative.

Taxpayers can establish Sec. 530 Coverdell ESAs (formerly known as Education IRAs) by setting up a trust specifically to pay qualified education expenses (QEEs) to be incurred by the designated beneficiary of the account. Sec. 529(e)(3) defines QEEs as tuition, room and board, fees, tutoring, services for special-needs students, books, supplies, computer hardware and software (including Internet access), uniforms and transportation. Unlike most other education plans, the Coverdell ESA covers the QEEs of a beneficiary attending elementary or secondary school (i.e., K-12).

For a contribution to a Coverdell ESA to qualify, there are both income limits and age requirements. First, under Sec. 530(b)(1)(A)(ii), a beneficiary must be under 18 when the tax-payers make the contribution. However, the beneficiary does not have to completely withdraw the funds invested in the account until he or she attains age 30, according to Sec. 530(b)(1)(E). If the beneficiary has not fully depleted the account by that age, the funds can be transferred to another beneficiary. This transfer is tax-free under Sec. 530(d)(5), as long as the new beneficiary is a qualifying family member under age 30, who withdraws the funds within 30 days of attaining age 30 and deposits them into another Coverdell ESA within 60 days.

Second, the maximum contribution for each beneficiary phases out when the donor's adjusted gross income is between $95,000-$110,000 ($190,000-$220,000 if filing a joint return). Because contributors need not have earned income, it is possible for a child to make the contribution if the parents do not qualify, as long as the child's income does not exceed the limits. The parents can simply gift the money to the child, who then makes the contribution. Contributors must make deposits to the account in cash by the filing date of their original income tax return, without extensions. Under Sec. 530(b)(5), such a contribution is deemed made by the end of the preceding tax year.

The annual contribution limit is $2,000 for each qualifying designated beneficiary. There is no limit to the number of accounts that taxpayers can set up for each beneficiary. However, if they establish...