Coverdell Education Savings Accounts (ESAs), like 529 savings plans, offer a tax-smart way to fund education expenses:

  • Contributions aren’t deductible for federal purposes, but plan assets can grow tax-deferred.
  • Distributions used to pay qualified expenses (such as tuition, mandatory fees, books, equipment, supplies, and, generally, room and board) are income-tax-free for federal purposes and may be tax-free for state purposes.
  • You remain in control of the account – even after the child is of legal age.
  • You can make rollovers to another qualifying family member.
  • One major ESA advantage over a 529 plan is that tax-free distributions aren’t limited to college expenses; they also can fund elementary and secondary school costs. Many taxpayers have been taking advantage of this by using ESA funds to pay for such expenses as tutoring or private school tuition.

However, if Congress doesn’t extend this treatment, distributions used for precollege expenses will be taxable starting in 2013. So you can’t count on using tax-free ESA funds to pay these expenses next year – which essentially means as soon as the second half of the new school year.

Barring congressional action, ESAs will become less attractive in 2013 for an additional reason: The annual ESA contribution limit per beneficiary, currently $2,000, will go down to $500 for 2013. Contributions (both in 2012 and 2013) are further limited based on income.