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Ask Dave

ESA - Tax Free or Tax Deferred?

Dave breaks down the taxation of an ESA and what happens if all the money is not used.

QUESTION: Allen wants to know how an Educational Savings Account (ESA) grows – tax free or tax deferred?  If his child cannot use all the money in the ESA, what happens to the investment?

ANSWER:  It grows tax-free, like a Roth IRA.  You’re allowed to put up to $2,000 a year into an ESA if you make less than $200,000 a year.

The money can be transferred to another sibling until he/she is 30 years old.  Otherwise, you’ll be taxed heavily on whatever you cash out. 

The ESA is the best place to save for your kids’ college education.  Even if you get a full-ride scholarship, you’ll still need this money to cover education related things like college living expenses, textbooks, meal plans, etc.