What Is an Education Savings Account (ESA)?

If you are wanting to save money for your kids, the next question is always “what type of account should I open for them?”

The answer depends on the goal for the money. If you want them to be able to use it for anything that they need/want (ie: house, car, etc) then you will likely want to open an UTMA for them. Here is an article that outlines all the details of an UTMA account.

If the answer is that you want to help them pay for college, then you will want to look at an account that is specifically designed for that, such as an Education Savings Account (ESA).

The Basics of an Education Savings Account (ESA)

An ESA is an account that is specifically designed to save money in order to pay for education expenses. The money you contribute to an ESA is after-tax. It grows tax-deferred meaning that as long as the withdrawals are used for qualified education expenses, you do not pay federal taxes on the money.

Qualified expenses include tuition, books, supplies, uniforms, room & board, computer equipment, and internet service

Tax-free withdrawals also apply for elementary and secondary education expenses as well.

So, essentially you can use the ESA to pay for kindergarten through college.

The ESA account is opened for a child (beneficiary) that is under 18 and there is a custodian (typically a parent or legal guardian) that manages the account until the child needs to use the money for education expenses.

Investment Options for ESA

There is a wide range of investment options in an ESA. The money can be invested in any type of stocks, bonds, mutual funds, etc. What this means is if you have an ESA for your child, you can have that money invested in the same funds you use in your retirement accounts. Having the flexibility to pick the investment options is definitely a perk of the ESA.

Contribution limits of ESA

The contribution limit for the ESA is $2,000 per year per child. You can contribute to the account until the child is 18.

Income limits of ESA

There are income limits in order to be eligible for an ESA which means that the contribution into the ESA can only be deposited by individuals whose modified adjusted gross income (MAGI) is below a certain amount. This is subject to change but currently contributions start phasing out at $95,000 for those that file single, head-of-household, or married filing separately and they start phasing out at $190,000 for those that file married filing jointly.

What if my child doesn’t use the money in the ESA?

The money in the ESA has to be used by the time the beneficiary turns 30. If it isn’t, the money will be distributed and the earnings portion of the account will be taxed as income plus subject to a 10% penalty tax. If the beneficiary of the account does not plan to use any more of the money in the account for education expenses before they turn 30, you can transfer the account to another qualifying beneficiary. Qualifying beneficiaries include the beneficiary’s child, sister, brother, first cousin and others.

Key Take-Aways

  • The ESA is an account specifically designed to save money in order to pay for qualified education expenses.
  • The annual contribution limit is $2,000 per year per child.
  • There are a wide range of investment options for the money in the ESA.
  • There are income limits in order to be eligible for an ESA.
  • The money being saved into the account is after-tax but the withdrawals are tax-free as long as they are used for qualified education expenses.
  • The money has to be used by the time the beneficiary is 30 and/or needs to be transferred to a qualifying beneficiary.

Questions?

We have 5 Financial Planners on our team that would be more than happy to discuss the specifics of saving for your child(ren)’s future. You can meet our team and reach out to one of us here!

 

 

Whitaker-Myers Wealth Managers, LTD is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.