- An Education Savings Account (ESA) functions much in the same way that a Roth IRA does. Contributions to an ESA are made with after-tax dollars and are allowed to grow tax-free and withdrawals may be made tax-free under certain conditions. Funds are held in a custodial account and up to $2,000 may be contributed annually until the student turns 18.
- To be eligible to contribute to an ESA, you must meet certain income requirements. If your tax status is filing single, your modified adjusted gross income must be no more than $95,000. If you file jointly, your modified adjusted gross income may be no more than $190,000.
- Funds held in an ESA may be used for qualified educational expenses at eligible educational institutions. Qualified expenses include tuition, fees, books, supplies and equipment. Room and board may also be covered if the student is enrolled on at least a half-time basis. An eligible educational institution is any college or university that is able to participate in federal student aid programs.
- The main advantage of an ESA is the tax benefits it provides with regard to earnings and withdrawals. Funds are transferred from parent to student when the student turns 18, which relieves parents of any potential future tax penalties.
- With a maximum contribution of $2,000, an ESA doesn't allow as much room to save as do other savings plans. If funds are withdrawn for purposes other than qualified educational expenses, then a 10 percent withdrawal penalty may apply. Earnings must be withdrawn prior to the student turning age 30 or else they are subject to federal income tax. Funds held in an ESA are considered an asset of the parent and may impact the student's federal aid eligibility.
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