How Does a Coverdell Education Savings Account Work?

Bill Nelson is a planning excellence lead consultant at Northwestern Mutual.

As with preparing for any financial goal, strategy is key. When you’re planning how to save for college, you’ve got a variety of custodial accounts to choose from. You’re probably familiar with the most common college savings option—the 529 plan—but there are other college savings options that can provide different benefits. A Coverdell education savings account (ESA) is one of these options.

Like a 529 plan, a Coverdell education savings account offers tax benefits as you save for college, but there are some key differences between the two. Here you’ll learn the basics of a Coverdell ESA, how it works and how it compares to a 529 plan. That way, you can decide whether you might want to open one.

What is a Coverdell education savings account?

A Coverdell education savings account is a type of custodial account you can open for a minor to save for education. Like other college savings options, it has certain tax benefits. Any contributions you make to a Coverdell account can grow tax-deferred and be withdrawn income tax-free as long as funds are used for qualified education expenses.

How does a Coverdell education savings account work?

When you open a Coverdell ESA, you’ll open it in a child’s name. At that point, two limits come into play. Anyone is able to contribute to the account as long as:

1. Their income is within the limits. The maximum contribution is $2,000 per year, but it could be less or even zero depending on tax filing status and income. The income number used is the modified adjusted gross income, known in the tax world as MAGI. Some people’s high income means they can contribute only a reduced amount or nothing at all.
2. The total contribution to all accounts on behalf of a beneficiary in any year can’t exceed $2,000.

Keep in mind that contributions must be made in cash, and they’re not tax deductible.

Once you set up the Coverdell savings account, you’ll select investments that will help the money in the account grow, tax-deferred. Compared with 529 plans, Coverdell accounts allow you to direct your money into a wide range of investments. These can include many common types of investments, like individual stocks, bonds, exchange-traded funds, mutual funds or real estate investments.

You’re able to withdraw money at any time from a Coverdell account to cover qualified education expenses. And as long as you use the money for qualified expenses, you won’t have to pay tax on it. The nice thing about a Coverdell ESA is the flexibility. It covers a broader range of educational expenses compared with a 529 plan.

What can a Coverdell ESA be used for?

With a Coverdell savings account, qualified education expenses can include the following:

• Elementary or secondary school expenses (including tuition, uniforms, transportation or computer equipment for kindergarten through grade 12)
• Housing and meals
• Higher-education tuition for students attending at least half time
• Books and equipment
• Special-needs services or academic tutoring

Any earnings you withdraw that are not used for qualified education expenses are subject to income tax as well as a 10 percent penalty. So it’s really in your best interest to make sure these funds go toward qualified expenses. (If you don’t need all of the money for education expenses, or if your child decides not to go to college, you do have some options for accessing the money.)

What happens to a Coverdell if the child doesn’t go to college?

A Coverdell account must be emptied (or “liquidated”) within 30 days after the beneficiary turns 30 (unless special needs are involved). So, if your child decides not to go to college, you could simply withdraw contributions and earnings from the account. You won’t be penalized on the contributions. But you’ll pay a 10 percent penalty plus income taxes on the money earned, known as “appreciation.”

If the beneficiary has special needs, the 30-year age limit doesn’t apply, and the funds can remain in the account until the beneficiary’s death.

Another option is to change the name of the beneficiary on the account. It can be changed to a younger sibling or even another eligible relative who is younger and has education expenses. The IRS specifies the type of eligible relative, and you can change the beneficiary once per year. You may also be able to roll funds in a Coverdell ESA into another ESA or 529 plan.

Who can open a Coverdell account?

Adults whose income falls within a certain range can open a Coverdell account for a minor. In 2025, a married couple who files jointly with a MAGI below $220,000 or a single taxpayer with an adjusted gross income below $110,000 is eligible to open and contribute to a Coverdell account.

Though the parents don’t necessarily need to be the ones to open an account for the child, the account ownership could impact how much the child is able to take out in student loans. Once the account is established, anyone whose income falls below the limit is able to contribute to the account. Contributions must stay within the annual contribution limit, which is $2,000.

2025 Coverdell ESA contribution limits

Congress limits how much can go into a Coverdell savings account each year. These limits apply to the account beneficiary—not to the contributor. So, a beneficiary can receive only $2,000 in contributions to any Coverdell account each year, no matter who contributes.

Your income, specifically your MAGI, also impacts how much you’re able to contribute. Here are the limits for the 2025 tax year.

• People who file federal taxes as single status: Contribution maximums are gradually reduced between $95,000 and $110,000. Single filers who make more than $110,000 cannot contribute.
• People who file federal taxes as married filing jointly: Contribution maximums are gradually reduced between $190,000 and $220,000. Joint filers who make more than $220,000 in combined income cannot contribute.
• Corporations, trusts and similar organizations can contribute regardless of their income.

Once the beneficiary of the account turns 18, you’re no longer able to contribute to the account (however, if the beneficiary has special needs, you may be able to contribute for a bit longer). This age limit can be a disadvantage if your child takes a gap year or works before attending college because you can’t contribute during that time.

What’s the difference between a 529 and a Coverdell ESA?

As with saving for retirement, diversifying your college savings can be a great way to make sure you make the most of each tax-advantaged vehicle and spread out your risk. So, you could consider opening both a Coverdell ESA and a 529.

Here are the major differences between the two account types:

Age requirements

Funds in a Coverdell savings account must be used by the time the beneficiary turns 30. If the funds aren’t used by then, the beneficiary will be subject to tax, penalties and possible fees upon withdrawal. With a 529, there are no restrictions on how old the beneficiary must be to use the funds.

If you’re left with unused funds in either a Coverdell account or a 529, you could change the name of the beneficiary to cover educational expenses for another child. But with a 529 plan, you may be able to roll unused funds (subject to the annual Roth IRA limit, which is $7,000 per year in 2025 for beneficiaries under age 50) up to a total of $35,000 into the beneficiary’s Roth IRA as long as you’ve had the plan for at least 15 years.

Contribution limits

Both Coverdell accounts and 529 plans have contribution limits, but the rules are quite different.

The annual Coverdell contribution limit is $2,000 per year, whereas the 529 plans do not have an annual contribution limit. (But with a 529 plan, you will need to consider the gift tax consequences for large gifts). The lifetime limit for a 529 plan varies by state from $235,000 to $500,000.

Qualified education expenses

Though both accounts can cover education expenses, Coverdell accounts can typically be more helpful than a 529 plan in covering K–12 expenses (including equipment, tutoring and other needs). To pay for eligible elementary and secondary school expenses, you can withdraw only up to $10,000 per year from a 529 plan (depending on the state). A Coverdell ESA doesn’t have any limit on how much you can withdraw to cover these expenses.

A 529 plan, though, can cover some expenses that a Coverdell savings account can’t. You also may now be eligible to use up to $10,000 per year from a 529 to repay student loans. (Funds in a Coverdell ESA cannot be used to repay student loans.)

Investments

Both accounts allow you to invest for education, so you’re subject to the ups and downs of the market—and could lose money.

One of the biggest differences between a 529 plan and a Coverdell savings account is the range of investments available to you. With a 529, you’re generally more limited as to which funds you’re able to invest in, but you’re typically able to choose from investment options in your given plan. But with a Coverdell ESA, you’ll often have a full range of investments—stocks, bonds, mutual funds or exchange-traded funds—for your dollars. This wider range gives you more options to consider as part of your investment strategy.

How to open a Coverdell education savings account

Before opening a new savings account, it’s a good idea to understand how it would work with existing ones. You’ll want to see how it could fit your cash flow and monthly budget. Your Northwestern Mutual financial advisor can be really helpful with this exercise.

They can help you look at your savings goals—including paying for education—and recommend options specific to you. Your advisor can also help you see the big picture, keeping other financial goals—like saving for retirement—in mind. However you choose to save, it’s helpful to plan ahead and be strategic with where you put your money to make sure you get the most out of your savings.

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