Lost in the fiscal cliff discussion has been any hint of whether Coverdell Education Savings Accounts (ESAs) will be permitted to continue in their current form. As it stands, beginning January 1, parents will no longer be able to use these accounts for expenses for kindergarten through high school without paying an onerous level of taxation.
Coverdell ESAs enable users to invest up to $2,000 per child per year in certificates of deposit, stocks, bonds, or mutual funds. Users can choose the types of investments. These funds then earn tax-free interest and can be used to pay for future education expenses, such as private-school tuition, computers, tutoring, and Internet learning. Disbursements for qualified education expenses are also tax-free, meaning users pay no penalties, income taxes, capital gains taxes, dividend taxes, or any other taxes on the account.
Unless action is taken, the law will change next month. Accrued earnings will be taxed when used for kindergarten through 12th grade, and a 10 percent penalty for withdrawing money before college will apply.
Allowing Coverdell account disbursements for K through 12 to expire would be painful for many middle-class families. Coverdell accounts have empowered parents to better expand their children’s educational options. Many parents have Coverdell ESAs planning to one day use those funds to help educate their children in elementary or high school. For many, their dream is endangered unless the Coverdell ESA rules are extended as a part of the fiscal cliff negotiations. Their money will be off-limits until college.
With the poor quality of many public high schools in America, these children might not be adequately prepared for college without access to these accounts. Congress and the President should remove the uncertainty and permanently protect Coverdell ESAs from taxation.