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Education Planning
Coverdell Education Savings Account
A Coverdell Education Savings Account (ESA) was created in 1997 by Congress exclusively to help pay qualified education expensed for the benefit of your child. The funds can be used for higher education as well as elementary and secondary school education expenses. A Coverdell ESA may be established for the benefit of any child under the age of 18: after the child reaches the age of 18, contributions are no longer accepted (the age limitation is waived for a special needs beneficiary).
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*Qualified expense
“Qualified elementary and secondary education expenses” are expenses related to enrollment or attendance at an eligible school. These expenses include tuition and fees, books, supplies, equipment, academic tutoring or special needs services for a special needs beneficiary.*
“Qualified higher education expenses” are expenses required for the enrollment or attendance of the designated beneficiary at an eligible education institution. The following items are qualified education expenses:
Tuition and fees;
The cost of books, supplies, and equipment;
Amounts contributed to a qualified tuition program;
In some situations, the cost of room and board.
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Tuition and fees;
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The cost of books, supplies, and equipment;
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Amounts contributed to a qualified tuition program;
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In some situations, the cost of room and board.
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The cost of room and board is a qualified education expense if the designated beneficiary is at least a half-time student at an eligible educational institution. A student is enrolled “at least half-time” if he or she is enrolled for at least half the full-time pursuing, as determined under the standards of the school where the student is enrolled. The expense for room and board is limited to one of the following two amounts.
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1.
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The school’s posted room and board charge for students living on campus.
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2.
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$2,500 each year for students living off campus and not at home.
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Expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible educational institution.
* Regulations defining special needs beneficiary still have not been released.
Effect of a non-qualified withdrawal
Generally, if a designated beneficiary withdraws an amount from a Coverdell ESA and does not have any qualified education expenses during the taxable year, a portion of the distribution is taxable. The taxable portion is the amount that represents earnings that have accumulated tax-free in the account. Figure the taxable portion as shown in the following steps.
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1.
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Multiply the amount withdrawn by a fraction. The numerator is the total contributions n the account and the denominator is the total balance in the account before the withdrawal(s).
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2.
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Subtract the amount figured in (1) from the total amount withdrawn during the year. This is the amount of earnings included in the withdrawal(s).
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3.
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Multiply the amount of earnings figured in (2) by a fraction. The numerator is the adjusted qualified education expenses paid during the year and the denominator is the total amount withdrawn during the year.
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4.
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Subtract the amount figured in (3) from the amount figured in (2). This is the amount the beneficiary must include in income.
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Example. You receive an $850 distribution from a Coverdell ESA to which $1,5000 has been contributed. The balance in the account before the withdrawal was $1,800. You had $700 of adjusted qualified education expenses for the year. Using the steps above, you figure the taxable portion of your withdrawal as follows.
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1.
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$850 x ($1,500&Mac184; $1,800) = $708 (basis portion of distribution)
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2.
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$850 - $708 = $142 (earnings included in distribution)
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3.
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$142 x ($700&Mac184; $850) = $117 (tax-free earnings)
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4.
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$142 - $117 = $25 (taxable earnings)
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You must include $25 in income as withdrawn earnings not used for qualified education expenses.
Additional Tax. Generally, if you receive a taxable distribution, you also must pay a 10% additional tax on the amount included in income.
Exceptions. The 10% additional tax does not apply to distributions that are:
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1.
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Made to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary.
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2.
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Made because the designated beneficiary is disabled (defined later).
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3.
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Made because the designated beneficiary received a qualified scholarship excludable from the gross income, Veterans’ educational assistance, or any other nontaxable payments (other than gifts, bequests, or inheritances) received for education expenses.
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The 10% additional tax also does not apply to a distribution that is a return of an excess contribution. For the additional tax not to apply, the distribution must be made before June 1st of the next tax year and it must include any net income attributable to that contribution. The net income also must be included in the contributor’s gross income for the tax year the contribution was made.
Disabled. You are considered to be disabled if you show proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long-continued and indefinite duration.
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