Education Savings Account (ESA) Rules Clarified

March 10, 2010

Author: Catherine M. Callery (Kate)| Louise M. Tarantino

In February 2010, SSA updated POMS SI 01130.460 on Coverdell Education Savings Accounts (ESAs).  A Coverdall ESA is an account(s) established to pay the educational expenses (i.e., elementary, secondary, and postsecondary school) of an individual who is the designated beneficiary and is under age 18 or a special needs beneficiary.

Generally speaking, Coverdell ESAs (previously known as Education IRAs), are much like 529 accounts, only different in their establishment and administration. The POMS allows that $2,000 per year per donor per designated beneficiary may be contributed to an ESA (that’s a tax rule; see a tax   advisor for additional nuances).  Additionally, contributions may be made only for designated beneficiaries younger than age 18, or 18 and older if they are a “special needs beneficiary.”  Regulations defining a “special needs beneficiary” have not been released by the Internal Revenue Service (IRS), but SSA assumes an individual who is age 18 or older and eligible for Supplemental Security Income (SSI) due to blindness or disability is a “special needs beneficiary.”

An ESA is excluded from resources for the designated beneficiary; a contribution to an ESA by an SSI recipient is treated as an uncompensated  transfer, but is exempt if the designated beneficiary is “disabled” as defined for SSI benefits.  An individual may contribute to his or her own ESA. Distribution of funds contributed by the designated beneficiary from an ESA becomes a countable resource if retained in the month after month of distribution, regardless of purpose of distribution. Distribution of funds contributed by another from an ESA becomes a countable resource if retained in the 10th month after month of distribution, regardless of purpose of distribution.

Interest and dividends earned on an ESA are treated as growth from an investment, and are excluded from income. Distribution from an ESA is presumed to be made first from funds contributed by another, and only after that amount is used up, from funds contributed by the designated beneficiary, when contribution has been from more than one source. Distribution from an ESA used for non-educational purposes is income to the designated beneficiary,  regardless of where the money goes.  Furthermore, a distribution of funds from an ESA becomes income, even during the period when it is excluded from resources, at the point when it is actually used for non-educational purposes, or when it is not intended for educational purposes (i.e., the distribution may change its character from exempt to counted income while being retained, or it may be income at the moment of distribution).  The POMS section defines permitted educational expenses and provides guidelines for determining the value of an ESA and accounting for its use.

An ESA may be maintained to age 30 + 30 days or until death + 30 days if the beneficiary dies before age 30 or is a special needs beneficiary.

The updated POMS section is located at https://s044a90.ssa.gov/apps10/poms.nsf/lnx/0501130460.