I currently have a Coverdell Education Savings Account for my children. The money is to be used for college. When I withdrawal the funds to pay for their college starting on 2013, would the earnings be tax free? I’ve read several articles that say as long as qualified expenses (say tuition) it would not incur a penalty or tax. I’ve read another article that states I would not incur a penalty but would have to pay tax on the earnings. Can you help?
Thank you for your question. The rules in 2010 were that the distribution was tax free as long as it was used for qualified education expenses. Unfortunately, the rules were set to return to what they were prior to the Bush tax cuts, which meant that they were taxable – in other words, the income accumulated tax free and distributions were taxable, much like the way a traditional IRA works. I do know that there were proposals to restore the more favorable rules we have now, but I have not verified as of yet whether the current rules were extended with the recent bill passed by Congress. I will be happy to find out for you, however. I am currently out of the office, but I will try to get the info when I return and I will email you what I find out.
Good news for Coverdell Education Savings Accounts! As part of the tax cut compromise signed by President Obama on December 17, 2010, the favorable rules for Coverdell Education Savings Accounts (ESAs) have been extended through 2012. The rules were scheduled to revert to the way they were in 2001, when the contribution limit was only $500 and, worse, distributions for qualified education expenses were at least partially taxable. Under the rules in effect since 2002, which are now extended through 2012, the contribution limit is $2,000 per year until the child reaches 18 years old (unless they are disabled), and most importantly distributions for qualified education expenses are tax free. Qualified education expenses are broadly defined and include certain expenses for kindergarten through college. Look for an article soon in the IRA and 401(k) Insights for more details.