Want Tax-Free Savings for a Child’s Education? You Can Self-Direct a Coverdell ESA, Too

Published on January 3, 2018

A Coverdell Education Savings Account (formerly known as an education IRA) is a trust account you can use to fund qualified educational expenses for designated beneficiaries up to age 18.

The funds from Coverdell ESAs are withdrawn tax free when used for educational purposes, assuming they are less than the account holder’s (the student’s) annual adjusted qualified education expenses. If the distributions are higher than the expenses, the gains are taxed at the account holders’ rate, rather than the contributor’s rate which tends to be higher.

You are permitted to open more than one ESA for a single beneficiary but the total maximum contribution per year for any single beneficiary is $2,000.  Therefore, if parents and grandparents set up separate Coverdell accounts for a child, the total that may be contributed for that one child among all of those accounts is $2,000. Once the account is established, anyone – including non-family members or charitable organizations – can make contributions within the Coverdell’s annual limit.

The designated beneficiaries of these accounts must be below the age of 18 when the account is established (contributions may be made up until the individual reaches age 18), with the exception of students with special needs. Additionally, the designated beneficiary must be at least a half-time student in order for distributions to remain tax-free. All money withdrawn from Coverdell accounts must be used for qualified educational expenses, including tuition, fees, tutoring, uniforms, transportation, room and board, books and other equipment required for schooling.

Considering the low annual contribution limits associated with Coverdell ESAs, using the funds to self-direct your own investments can help families more rapidly increase the investment earnings to support their child’s education.

NOTE: A Coverdell ESA is different than the 529 plan (another way to save for college). One major difference is that a Coverdell ESA can be opened with a custodian/administrator of self-directed retirement plans, which means that savvy investors with experience investing in non-traditional assets can grow education savings by leveraging their existing skills. Additionally, Coverdells can be used for education expenses for grades K through 12 as well as college.

Self-directed Coverdell Education Savings Accounts

Self-directing a Coverdell ESA means that funds can be invested in a broad array of nontraditional investments; life insurance and collectibles are essentially the only investments not allowed through self-direction. The Coverdell funds may be invested in real estate, precious metals, commodities (agricultural, livestock, energy), notes, private placements and many other non-publicly traded assets. This can be a great way to move those education savings to the head of the class by developing a more eclectic portfolio within the account. As with all self-directed plans, all income and expenses related to the investments must flow through the account, and all transactions are executed by the third-party administrator/custodian.

Did You Know: Funds can remain in a Coverdell ESA until 30 days after the designated beneficiary reaches age 30. Any unused funds at that point become taxable and will be assessed a 10% penalty. Since there are income limits for those who contribute to Coverdell ESAs, we encourage anyone who opens or contributes to a self-directed plan of any kind to consult with his/her trusted financial or tax adviser.

If you’re ready to open a self-directed Coverdell ESA or any type of self-directed retirement plan, our online starter kits make it easy.  Have a question about a Coverdell or about the types of nontraditional investments allowed through self-direction? Next Generation Trust Company can help. Our team can answer your questions by phone at 888-857-8058 or email at Info@NextGenerationTrust.com.