These tax-advantaged accounts have many benefits, and they offer a great way to start saving for education costs. There are income requirements that exclude some upper-income families, however.

ESAs used to be considered a student asset by the Federal Methodology, but now they are regarded as a parent asset.

In fact, 529 plans and ESAs receive equal treatment in financial aid calculations using the Federal Methodology. Furthermore, qualified distributions from ESAs and 529 plans are not considered parent or student income and do not reduce financial aid eligibility.

Primary benefits

ESAs allow eligible parents, family members, and students to contribute up to $2,000 per year (until the child turns age 18) toward qualified education expenses at any college, university, vocational, elementary, or secondary school.

With an ESA, participants can benefit from tax-deferred growth and tax-free withdrawals when the proceeds are used for qualified education expenses.

Another benefit is the discretion the account holder has over the investment of their funds, which will be allocated in stocks, bonds, and mutual funds.

Advantages

• Contributions to ESAs for a particular year can be made until the tax return due date (generally April 15).
• The Hope and Lifetime Learning credits can be claimed in the same year that tax-exempt distributions are taken from ESAs.
• You can contribute to both an ESA and a 529 plan in the same year for the same beneficiary.

Restrictions on participation

ESAs have provisions that may prevent you from participating. For married taxpayers, the adjusted gross income phase-out range for contributions is up to $220,000. For single taxpayers, the phase-out range is up to $110,000.

The $2,000 maximum contribution applies to the account holder and beneficiary. The beneficiary can only receive a total contribution of $2,000 in any given year, regardless of the number of contributors to that account. Furthermore, the account holder can make a maximum contribution of $2,000 per beneficiary.

If there is a balance in the ESA when the beneficiary reaches age 30, it must be distributed within 30 days. A portion representing earnings on the account will be taxable and subject to the additional 10% tax. The beneficiary may avoid these taxes by rolling over the full balance to another Coverdell ESA for another family member.