Changes to Coverdell Education Savings Accounts (ESA) Starting January 1, 2011

Question:

From what I have read Coverdell Educational accounts will no longer be allowed to be established starting January 1, 2011. Does anybody know if you have already established one of these accounts before the end of this year if you can continue to make contributions to it or not?

Answer:

That is a great question!!! Thanks for sending it.  The answer is that unless Congress takes action, the rules for the Coverdell Education Savings Accounts will return to the rules as they were in 2001.  Essentially, the new/old rules will mean that the contribution limits will be reduced to $500 for 2011 and future years.  Worse, the extreme tax advantage of tax free distributions for qualified education expenses will be reverted to distributions being taxable but no penalty if used for qualified education expenses (although your contributions will not be taxed as they are returned on a pro rata basis).  Expenses will then be limited to college expenses, unlike the current rules where you can also fund primary and secondary education.  Contributions will not be able to be made to both a Coverdell ESA and a 529 plan in the same year. 

It’s very hard to say whether or not the government will reinstate the current rules, let the pre-2002 rules come back (thereby killing the effectiveness of ESAs) or if they will reach some middle ground.  I will keep watch over this issue and let you know if I find anything new out.

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