Education Savings Account Tutorial
Distributions
Distributions from an ESA are pro-rated between contributions and earnings. That means a distribution will come from either the portion of the ESA that represents contributions or the portion that represents earnings.
Distributions from ESAs that are used for qualified education expenses are tax and penalty free. A distribution that is not used for qualified education expenses (defined below) is subject to tax and an additional 10% early-distribution penalty if the distribution is taken from the ESA's earnings. A distribution of contributions, however, is always tax and penalty free because no tax deductions are allowed for amounts when they are contributed to the ESA.
Qualified Education Expenses
Generally, qualified education expenses are those required for the designated beneficiary's enrollment or attendance at an eligible school. These include certain higher-education expenses and certain expenses for education at elementary and secondary schools. Eligible schools include all public, private or religious schools that provide elementary or secondary education (kindergarten through grade 12) as determined under state law.
Qualified education expenses for ESA distributions include:
- tuition and fees
- books, supplies and equipment
- academic tutoring
- special-needs services for a special-needs beneficiary
- room and board
- uniforms
- transportation
- supplementary items and services (including extended day programs)
- computer technology, equipment or internet access and related services that are to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in school (excluding expenses for computer software designed for sports, games or hobbies, unless the software is predominantly educational in nature)
Tax Treatment of Distributions
As stated above, a distribution from an ESA that is not used for qualified educational expenses may be subjected to income tax and an additional 10% early-distribution penalty. The tax and penalty applies only to the earnings portion of the distribution. The 10% early-distribution penalty will be waived if the distribution occurs for any of the following reasons:
- The designated beneficiary dies, and the distribution goes to another beneficiary or to the estate of the designated beneficiary.
- The designated beneficiary becomes disabled. A person is considered to be disabled if there is proof that he or she cannot participate in any substantial gainful activity because of a physical or mental condition. A physician must determine that the individual's condition can be expected to result in death or continue indefinitely.
- The designated beneficiary receives any of the following:
- a qualified scholarship excludable from gross income
- veterans' educational assistance
- employer-provided educational assistance
- any other nontaxable payments (other than gifts, bequests or inheritances) received for education expenses
- The distribution is included in income only because the qualified education expenses were taken into account in determining the 'Hope Credit' or 'Lifetime Learning Credit', both of which are tax credits that reduce the amount of the taxable income of an individual funding a student's education. (An individual may be able to claim a Hope Credit of up to $1,500 for the qualified tuition and related expenses he or she pays. This credit applies for each eligible student the individual is funding. Also, an individual may be able to claim a Lifetime Learning Credit of up to $1,000 for qualified tuition and related expenses he or she pays for all students enrolled in eligible educational institutions.)
- The beneficiary distributes amounts that were in excess of the contribution limits (or earnings on these amounts), and the distribution occurs before June 1 of the year following the excess contribution.