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What is a Self-Directed Coverdell ESA?

self-directed coverdell esa

A Self-Directed Coverdell ESA is essentially the Coverdell Education Savings Account (ESA). This is a federally sponsored, tax-advantaged trust or custodian account. Formerly known as the Education IRA, it is designed to pay for qualified education expenses. With a Self-Directed Coverdell ESA, you have the additional benefits that come with a Self-Directed IRA. Among these benefits include:

  • Investment diversification
  • Tax-free or tax-deferred growth
  • The ability to plan for your child’s future. The funds in your Self-Directed Coverdell ESA allow you to use the account for primary and secondary schools (grades K–12) as well as higher education.
  • Additionally, the funds can be used for other educational expenses besides tuition.

Who can Establish a Coverdell ESA?

The Coverdell ESA can be opened for students under the age of 18, but the assets must be withdrawn once the student turns 30 years of age. Students with special needs have age restrictions on contributions and withdrawals to the Coverdell ESA.

The tax treatment of Coverdell ESA contributions and earnings

For 2023 and 2024, annual contributions of no more than $2,000 each year can go toward the beneficiary of the Coverdell ESA. Contributions are not tax-deductible, however, funds contributed to the account grow tax-free until the beneficiary takes a distribution. Withdrawals are tax-free, much like a Roth IRA, if the withdrawal does not exceed the beneficiary’s qualified education expenses.

Coverdell ESA Contribution Rules

Friends and relatives (parents, grandparents, and other relatives) can contribute to the Coverdell ESA. The student for whom the account is established can also make contributions. Since 2002, certain corporations have also been permitted to make contributions to the Coverdell ESA.

Individuals who have a modified adjusted gross of income less than $110,000 can make contributions. Couples filing a joint return can contribute if they make less than $220,000.

Coverdell ESA withdrawals Rules

Individuals can make withdrawals from a Coverdell ESA to pay for qualified education expenses at elementary and secondary schools, and public, private, and religious schools. Withdrawals can also go toward college, university, and even vocational school or other post-secondary educational institutions that can participate in a student aid program by the Department of Education. This includes all accredited, public, nonprofit, and private post-secondary institutions.

What Expenses Can Be Paid with Coverdell Funds?

It is important to note that individuals can only use Coverdell ESAs to pay for qualified education expenses. This includes:

  • Tuition and fees
  • Books
  • School supplies/other equipment (i.e., computer equipment)
  • Academic tutoring
  • In certain cases, the cost of room and board, transportation, and uniforms

For students with special needs, Coverdell ESA funds can also go toward special needs services.

Withdrawal Rules for Coverdell ESA

You can make a distribution at any time, but it must go toward the payment of a qualified education expense for the student/beneficiary. This distribution generally will not be taxable income and must be used before the student turns 30. Again, this does not apply to special needs students, as there are no age restrictions.

When the beneficiary reaches age 30, the Coverdell ESA funds can be distributed to him/her, but it will be considered taxable income. The alternative is to perform a rollover, where the Coverdell ESA funds roll over to another Coverdell ESA for an eligible family member. This must occur before the primary beneficiary turns 30.

The earnings portion of a Coverdell ESA distribution that is not considered to be for qualified education expenses will be included in the gross income of the beneficiary and an additional 10 percent tax penalty may apply.

Establishing a Coverdell ESA with IRA Financial

You will benefit by establishing a Coverdell ESA with IRA Financial by using the account to make alternative asset investments. You can invest in assets you know and trust, such as real estate, precious metals, and many other investments.

Why use your funds to make investments? Consider this: the annual contribution for limiting this type of account is just $2,000 per year. If you established the account for your newborn, you could save at least $36,000, over an 18 year period, plus all the appreciation from the investments.  Based on the rule of 72, assuming a 9% annual rate of return, your money would double every 8 years.

Because of this, many individuals like having the opportunity to use their funds to invest in what they know.

What Investments are Prohibited with a Coverdell ESA?

A Self-Directed IRA can invest in practically anything. The Internal Revenue Code does not state what you can invest in with your Self-Directed IRA funds, only what you cannot invest in. As a result, there are certain rules you must adhere to, known as the prohibited transaction rules.

These rules are very few and state that the Self-Directed Coverdell ESA cannot:

  • Invest in prohibited transactions such as collectibles and insurance
  • Invest with disqualified person with whom the account holder has a close relationship

These rules encourage you to make wise decisions on behalf of your IRA, and not yourself.

If you follow these rules, you can use your account funds for almost any investment. But if you do not follow the rules, be aware that you can incur high penalties.

Checkbook Control with a Coverdell ESA?

A Self-Directed IRA with checkbook control gives you complete control over your funds and investment choices. You can have checkbook control with a Coverdell and make investments without custodian consent. For example, if you want to make a real estate investment and need to act fast before losing the investment, you can write a check from your Self-Directed IRA LLC bank account or wire the funds and quickly make the purchase. If you had a Self-Directed IRA with custodian control, you will most likely lose the investment opportunity due to custodian delays.

Related: What is a Checkbook Control IRA?

Checkbook Control – How it Works

Under the checkbook control structure, the Coverdell is set up as a self-directed account that is funded by your current retirement account through a rollover. A limited liability company (LLC) is created, which the Coverdell account will purchase. As a result of this, your money is held in an LLC, which allows you to invest as you please.

A Self-Directed Coverdell comes witseveralof benefits:

Get in Touch

The Self-Directed Coverdell LLC is popular for real estate transactions, tax liens & deeds, cryptocurrencies, and hard money loan investments. If you have questions about the Self-Directed Coverdell ESA, contact IRA Financial directly at 800-472-0646. You can also fill out our form to speak with a specialist.


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