Bloomfield State Bank's Coverdell Educational Savings Account
What Is a Coverdell Education Savings Account (CESA)?
The Coverdell Education Savings Account is a nondeductible account that features tax-free withdrawals for a very specific purpose, a child's higher education expenses.
At first glance, the CESA looks similar to traditional and Roth IRAs. After all, higher education distributions are permitted from these accounts as well. The crucial difference is that while qualified higher education distributions from a traditional or Roth IRA are penalty free, the same distributions from an CESA are penalty free and tax-free.
NOTE: While the Taxpayer Relief Act of 1997 created this new account, the IRS has not yet defined or clarified much of the law. Consult your tax adviser for further information.
Am I eligible to Contribute to a CESA?
There are two eligibility considerations for an CESA. First, the child for whom you are contributing may not have had any contributions made on his or her behalf to a state prepaid tuition program in that year. Second, your modified adjusted gross income (MAGI) cannot exceed certain limits (see table below).
There is no requirement that the contributor have earned income. Nor is there any requirement that the contributor be under age 70 1/2.
How Much Can I Contribute?
The total aggregate contribution into one or more CESAs on behalf of a child is $2,000 for a taxable year. As a contributor, your allowable contribution depends on your MAGI. The MAGI limits are:
How Does the Law define a "Child"?
A child is defined as a person who is under the age of 18. Contributions may be made on behalf of a child until the day before his or her 18th birthday. Contributions on behalf of an individual age 18 or older are not permitted.
What if I Want to Save for More Than One Child?
The law appears to allow contributors to deposit their maximum allowable contribution into CESAs for as many children as desired.
Do I Pay Taxes on the Earnings?
No and neither does the child (provided the money is used for qualified higher education expenses). That's the best part of the CESA. Unlike a traditional IRA, you cannot take a tax deduction for any of the contributions that you make to a CESA. However, when the beneficiary is ready to take his or her withdrawal for school, there are no taxes due on any of the interest that your money has earned.
What Is a Qualified Higher Education Distribution?
The term "qualified higher education expense" means tuition, fees, books, supplies, and equipment required for the enrollment or attendance at an eligible higher education institution. Basically, an eligible higher education institution is an area vocational school or university.
Distributions must be made during the year in which the education expense occurred. If distributions exceed the educational expenses, the additional amount withdrawn is a nonqualified distribution.
What Is a Nonqualified Distribution?
A nonqualified distribution is any distribution other than a higher education expense distribution.
When a nonqualified distribution is taken, a ratio of contributions and earnings is withdrawn. The earnings portion is then subject to taxes and a 10 percent penalty. Distributions made on account of death, disability, or scholarship are not subject to the 10 percent penalty. However, the earnings portion of such distributions is taxable.
Can I Move Funds From My Traditional or Roth IRA Into a CESA?
Unfortunately, no. You can, however, roll funds over from one CESA into a second CESA established for the same child.
Also, a twist with the new CESA is the ability to roll CESA assets into a CESA for a new designated beneficiary who is a member of the same family (as defined by law). That way, if a child decides not to pursue his or her education, the account can be transferred to a relative who does.
How Do I Open a CESA?
Simply see any of our IRA representatives. We will explain the nature of these accounts in more detail and help you complete the simple forms necessary to establish a CESA for a child.