A Coverdell Education Savings Account (formerly known as an Education Individual Retirement Account) is a tax-beneficial investment account designed to encourage savings for future college expenses.  The plan was named for its primary champion, U.S. Senator Paul Coverdell, now deceased.

The Coverdell account allows the investor to deposit funds and earn interest on them and later withdraw the funds for qualified educational expenses at a qualified institution without having to pay tax on the withdrawal.

Coverdell Education Savings Accounts (ESAs) have lower maximum contributions than their similar predecessors, 529 Savings Plans.  Coverdell ESAs allows only $2,000 per child per year, while the 529 Plans have no restrictions on contributions other than anything over $12,000 may be subject to a gift tax.

While the 529 Plans allow only a limited choice of state run programs in invest in, Coverdell ESAs allow almost any investment including stocks, bonds and mutual funds.  In addition, the disbursements of Coverdell plans are tax free if they are paid to a qualifying institution. 

The Coverdell disbursements for qualified educational expenses must be taken by the time the beneficiary is 30 years old.  It may also be gifted to another family member below the age of 30.  If the disbursements are not taken in accordance with the guidelines, the plan owner may be subject to taxes and penalties.

The income level of the donor may affect contributions to a Coverdell ESA.  However, the funds in a Coverdell plan are not considered in the beneficiary’s income when applying for federal financial aid as long as the owner of the account is not the student/beneficiary.  So, this helps to increase the potential financial aid for the student since the Coverdell account cannot be considered an asset of the student.

Should the named beneficiary decide not to attend college, the Coverdell ESA can be transferred to a new designee – without incurring taxes or penalties – as long as the new beneficiary is an eligible family member of the previous beneficiary.