The 1997 Tax Payer Relief Act created the Education IRA.
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It functioned much like a Roth IRA— contributions were not tax deductible and the money could be withdrawn tax free. The initial contribution cap was $500 per year per child, and the money could be used to pay for higher education expenses. In 2002, the Education IRA was renamed the Coverdell Education Savings Account (ESA,) and the contribution limit was raised to $2,000 per year.
The most important change made to the Education IRA in 2002 was allowing funds to be used for primary and secondary school expenses. While the previous Education IRA was restricted to higher education expenses, the Coverdell ESA could be used for college expenses and private elementary and secondary schools. This is one of the first times the government has allowed a savings account with tax benefits to pay for private primary or secondary school.
Like Roth IRAs, Coverdell ESAs do not restrict participation based on an individual's coverage under employer provided retirement plans. Another benefit of a Coverdell ESA is that they can be used in conjunction with a 529 plan.
In 2008, if you were married and filing jointly you were able to contribute to a Coverdell ESA if your modified AGI was below $195,000. If you were filing as single and had a modified AGI of less than $95,000 then you were able to contribute to a Coverdell ESA.
Contributions are made to a Coverdell ESA in the name of a beneficiary, who can be either a child or grandchild of the contributor. A beneficiary must be someone under the age of 18—a Coverdell ESA cannot be contributed to once the beneficiary reaches 18, but the funds are allowed to grow until the beneficiary reaches 30, at which point the funds must be distributed.
Coverdell ESAs are a great way to save for education expenses with money that grows tax free. To learn more about other IRA solutions, read about Traditional IRAs, SEP and Simple IRA plans, and Roth IRAs.