Education IRA

An individual savings account used for education expenses and offers tax advantages

What is an Education IRA?

An education IRA is an individual savings account used for education expenses and offers tax advantages. It was first implemented into law in the United States in 1997 through the Taxpayer Relief Act and is governed by Section 530 of the Internal Revenue Service (IRS) Code.

Education IRA

In 2002, education IRAs were renamed Coverdell Education Savings Accounts (ESA), in honor of Senator Paul Coverdell, who was credited with much of the work done to establish tax-advantaged educational savings accounts into U.S. law.

The tax advantages offered for ESAs were further secured by the American Taxpayer Relief Act of 2012.


  • An education IRA – more properly known as a Coverdell ESA – is a tax-advantaged savings account for educational expenses.
  • ESAs function like other self-directed IRAs, offering a wide range of investment choices.
  • Parents or guardians should consider the relative advantages and restrictions of an ESA and a 529 plan to determine which best suits their purposes.

Structure of an Education IRA

A Coverdell ESA is structured as a custodial savings account for educational expenses. A custodian or trustee who manages the account may be a parent who is saving for their child’s education, or an attorney, financial advisor, accountant, or tax advisor.

The ESA is operated in the same manner as any self-directed IRA – that is, the custodian or trustee can choose from several various investments.

The custodian of the account designates the account’s beneficiary, who may be any child under the age of 18 at the time they are named beneficiary. The beneficiary of the account may withdraw funds for education expenses up to the time they reach the age of 30.

If there are still funds remaining in the account at that time, they can be rolled over into a new education IRA for a new beneficiary.

For example, parents with more than one child can first name their oldest child as the beneficiary of the education IRA – then, when that child reaches the age of 30 or no longer needs funds from the account, they can roll over the remaining funds into a new account, where the named beneficiary is a younger child.

There are both income and annual contribution limits on Coverdell ESAs. Such accounts can only be established by individuals whose Modified Adjusted Gross Income (MAGI) is $110,000 annually or less. The income restriction for married couples filing jointly is $220,000 per year.

The maximum contribution that can be made to an ESA is $2,000 per year, as of 2020. It is a disadvantage for such accounts compared to the 529 educational savings plans that offer much higher allowable annual contribution amounts. The ESA’s primary advantage over a 529 plan is that it offers a wider range of investment choices.

Although beneficiaries of an ESA can have both an ESA and a 529 plan established for their benefit, they may not have contributions made to both plans in the same calendar year – contributors must choose one account or the other to contribute to each year.

Contributions made to an ESA are not tax-deductible. However, all funds deposited in the account may grow tax-free thereafter. There are no taxes on withdrawals from the account as long as the money is used for appropriate educational expenses.

ESA Qualifying Expenses

  1. Tuition and fees
  2. Travel expenses
  3. Books
  4. School supplies
  5. Uniforms
  6. Personal computers
  7. Room and board

Education IRAs – Acceptable Expenses

When making withdrawals for expenses, the custodian or trustee must be careful to ensure that the money is only used for approved educational expenses. Otherwise, it is subject to up to a 10% tax penalty.

Generally speaking, funds in an ESA may be used for both educational expenses related to K-12 schooling and higher education. More specifically, the funds are restricted to being used to cover the following types of education-related expenses:

  • Tuition and other admittance/attendance related fees, such as tutoring
  • Transportation expenses related to attending an educational institution
  • Books and similar materials needed for coursework
  • General school supplies, such as notebooks, pens, etc.
  • School uniforms
  • Equipment needed for school, such as computer hardware or software
  • Room and board expenses for students attending boarding school or boarding at a university

For room and board expenses to be a covered expense, the student must be enrolled in school on more than a half-time basis.

Notes for Using an ESA

As with any type of IRA account, the users of an education IRA must be careful to act within the restrictions of the applicable tax law. In addition to annual contribution limits and withdrawal restrictions, there are several details to note about the appropriate handling of an ESA.

One often-overlooked factor is the tax penalty for contributions made to an ESA after the beneficiary turns 18. Since beneficiaries are eligible to use ESA funds up to age 30, many parents mistakenly believe they can continue contributing to an ESA account without tax penalties up until then.

There is, however, a 6% tax levied on any contributions made after the beneficiary reaches age 18.

Also, Coverdell ESA funds will be considered if a student applies for financial aid. Fortunately, the student’s financial aid eligibility will only be reduced by 5.64% of the amount of money in their ESA at the time of application for aid.

Related Readings

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

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