Education Savings Accounts

A third type of tax break for educational expenses (including elementary and secondary education expenses) is the Coverdell education savings account (ESA), formerly known as an education IRA. "IRA" was something of a misnomer because this type of account is not designed to survive into the beneficiary's retirement. However, the account works similarly to a Roth IRA in that contributions are not deductible, but interest and dividends that build up within the account are tax-free, and amounts withdrawn from the account under proper circumstances will not be taxed.

ESAs are set up on a per-child basis, with a bank or other financial institution approved by the IRS. Each child must have one or more separate accounts, and the child, a parent, grandparent or friend may contribute up to $2,000 to the account. More than one person can contribute on behalf of the same child, but the total contributions for that child cannot exceed $2,000. No contributions can be after the child turns 18, and no contributions can be made in the same year that a contribution is made to a qualified state tuition program on behalf of the child.

• There are income restrictions on the persons who are able to contribute to education IRAs.
• Distributions from ESAs are not taxed if spent on qualified expenses; accounts can be rolled over to family members; if not spent or rolled over, the accounts must be distributed within 30 days after the beneficiary reaches age 30.