A Coverdell Education Savings Account (ESA) is a tax-advantaged savings account designed to help families save for college and K-12 education expenses. Similar to a 529 plan, investments in a Coverdell ESA grow on a tax-deferred basis and can be withdrawn tax-free to pay for qualified education expenses for a designated beneficiary. However, one of the biggest differences between a Coverdell ESA and a 529 plan is the available investment options.

Who can contribute to a Coverdell ESA?

Individuals with an annual income below $110,000 ($220,000 if married filing jointly) may contribute to a Coverdell ESA. The ability to contribute the maximum $2,000 per beneficiary is reduced on a ratable basis for incomes above $95,000 ($190,000). The income phaseouts do not change and do not adjust for inflation. 

Families can make contributions to a Coverdell ESA until the beneficiary reaches age 18. If the funds are not spent by the time the beneficiary turns 30, they will be distributed and taxable to the beneficiary. The $2,000 maximum annual contribution applies to all Coverdell ESA accounts opened for the same beneficiary, including accounts opened by grandparents and other relatives. 

What investment options are available with a Coverdell ESA?

Unlike 529 plans, Coverdell ESAs offer self-directed investments. Parents, grandparents and anyone else who meets the income requirements may open a Coverdell ESA through a brokerage account, bank, credit union or mutual fund company.

It’s important to compare fees and investment options when selecting a Coverdell ESA provider. The more you pay in fees the less you will be able to save for college. Parents should look for providers with $0 account minimums and no annual account maintenance fees. Transaction fees can also eat away at your college savings, so look for providers with low-cost options, such as commission-free ETFs.

Families can invest Coverdell ESA funds in any of the securities offered by the plan provider. This includes individual stocks, bonds, exchange-traded funds (ETFs), mutual funds and real estate investments.

For example, investors who open a Coverdell through American Funds can select investment options from:

  • American Funds Portfolio Series – Eight diversified portfolios that aim to meet long-term and short-term goals.
  • Individual Mutual Funds – Investors can create a portfolio of American Funds mutual funds or select a single mutual fund.

Investors who open a Coverdell ESA through a brokerage company, such as TD Ameritrade, have access to a wide range of ETFs, bonds, and domestic and international stocks. Opening a Coverdell ESA through a brokerage may be suitable for families who are comfortable building their own portfolio or who work with a financial advisor who can help select investments.

Can you change investments in a Coverdell ESA?

There is no limit to the number of investment changes a Coverdell ESA account owner can make, and changes can be made at any time throughout the year.

Coverdell ESAs generally do not offer age-based investment options, which are a popular option among 529 plan account owners. Age-based investment options automatically shift toward more conservative investment options as the beneficiary gets closer to college. Coverdell ESA account owners who want to reduce risk in their portfolio have to manually adjust investment allocations.

Can you rollover Coverdell ESA funds into a different account?

A rollover distribution from an existing Coverdell ESA account must be deposited into another Coverdell ESA account within 60 days to avoid taxes and penalty. The new ESA can be established for the same beneficiary, or a qualifying member of the beneficiary’s family who is below age 30. Rollovers can be made once in a 12-month period.

There is also an option to rollover Coverdell ESA funds into a 529 plan account for the same beneficiary in the same taxable year. Some parents may prefer to use a 529 plan if the 529 plan has lower fees, if they want to save more than the $2,000 limit per year, if the child is approaching the age limits for a Coverdell ESA or if they want more flexibility in case their child doesn’t go to college.