Coverdell Education Savings Accounts

You can use the Coverdell Education Savings Account (ESA) to help pay for your child’s elementary and secondary school expenses, as well as college expenses. The annual contribution limit is $2,000, but keep in mind that income limits apply. (Refer to the chart on page 11.) You have until the April tax filing deadline in 2021 to make contributions for 2020. Grandparents and other family members may also make contributions for your children, as can corporations and other entities. There is no limit to the number of accounts that can be held in a child’s name or the number of people who may make contributions to a Coverdell ESA—as long as total contributions remain within the $2,000 annual limit per child.

Funds withdrawn from an ESA (both contributions and earnings) are tax free if used to pay for qualified expenses. However, tax-free distributions are not allowed if an education tax credit is used for the same expenses for the same student. The beneficiary must use ESA funds by age 30. If not, the account may be transferred to a relative.

Education Bonds

Education Bonds offer tax-free interest on Series EE bonds issued after December 31, 1989, and all Series I bonds. Tuition and fees are qualified expenses. You can rollover an education bond into a 529 plan or Coverdell ESA. Income phaseouts for 2020 are $82,350–$97,350 for single and head of households and $123,550–$153,550 for married filing jointly. Some important notes: income limits apply when bonds are cashed; bonds must be in the parent’s name; the child must be the beneficiary, not co-owner; and the purchaser must be age 24 or older.

Education Tax Credits

If you are currently paying higher education expenses, two Federal tax credits may help lessen your tax bill: the American Opportunity Tax Credit and the Lifetime Learning Credit.

The American Opportunity Tax Credit is worth $2,500 in 2020. It is now available for all four years of college, and it can be used to cover the cost of course materials. Income phaseout levels for the credit begin at $160,000 of modified AGI for joint filers and $80,000 of modified AGI for single filers in 2020. In addition, 40% of the credit is refundable, which could enable lower-income taxpayers to get money back from the IRS.

The Lifetime Learning Credit, which applies to undergraduate study, as well as graduate and professional education pursuits, could be worth up to $2,000. For 2020, eligibility begins phasing out for joint filers with modified AGI of $118,000 ($59,000 for single filers). If a student qualifies for both credits in the same year, you may claim either credit, but not both.

If you cannot claim either credit because your income is too high, your child can take the full credit if he or she has sufficient taxable income. However, you will not be able to claim a dependency exemption for the child. Your savings, therefore, will be the amount of the credit less the tax benefit of the lost dependency exemption. But, be aware that, based on your income, the exemption may be reduced.

Consider whether it might be more beneficial for your child to file his or her own tax return and claim an education tax credit.