Taxpayers may make nondeductible contributions to a tax-favored account designed specifically for college, elementary, or high school education expenses—a Coverdell Education Savings Account (formerly known as an Education IRA).

Contributions of up to a total of $2,000 per year, per beneficiary, may be made to an account for the benefit of a beneficiary who is under age 18 (students with special needs can be over 18). In 2009 and 2010 income phase-out for contributions begins for taxpayers with modified adjusted gross income (AGI) above $95,000 ($190,000 for joint filers). No contribution will be allowed once modified AGI reaches $110,000 ($220,000 for joint filers).

SUGGESTION: If your modified adjusted gross income exceeds the limits, the child's grandparent or other relative may be able to establish the account and make the annual contribution.

SUGGESTION: Contributions can be made to an Education Savings Account regardless of whether or not the owner has earned income.

Earnings in an Education Savings Account grow tax-deferred, and are never taxed, provided they are used for the beneficiary's qualified education expenses. A HOPE Scholarship Credit or a Lifetime Learning Credit can be claimed for the eligible student in the same year as an Education Savings Account distribution as long as the distribution is not used to pay for the same costs used to claim the education credit. If withdrawals are not used for qualified education expenses, withdrawn earnings are included in the beneficiary's taxable income and are subject to an additional tax of 10%.

IMPORTANT NOTE: If the balance of an Education Savings Account is not distributed before the beneficiary reaches age 30, the account must be emptied upon attainment of that age, unless the individual is a special needs beneficiary. The earnings in the account are taxed at the beneficiary's income tax rate and are also subject to a 10% penalty since they will not have been used to pay qualified education expenses. These taxes can be avoided if the account balance is rolled over to another Education Savings Account benefiting a different beneficiary who is a member of the family of the previous beneficiary.

Here are some other facts regarding the Education Savings Account:

• Contributions qualify for the annual gift tax exclusion.
• An Education Savings Account can be set up for any child under 18; contributions generally cannot be accepted after the child's 18th birthday, unless the beneficiary is a special needs beneficiary.
• There is no limit on the number of Education Savings Account that may be established for a particular child, but the maximum aggregate contribution for any one child in any calendar year is $2,000.
• Contributions are not deductible.
• Only cash contributions are allowed.
• Subject to the applicable income limits, any individual may contribute to an Education Savings Account; the contributor does not have to be a relative. A child may contribute to his or her own Education Savings Account.
• A child may take tax-free withdrawals to pay qualified higher education expenses even if he or she is enrolled at an eligible educational institution less than full-time; enrollment on a half-time or less than half-time basis will qualify.
• If the beneficiary dies, the value of the account is includible in his or her taxable estate—not in the account owner's estate.
• The account is considered an asset of the parent when applying for financial aid if the parent is the owner of the account.

If you are eligible to establish an Education Savings Account and make the maximum annual contribution of $2,000 at the beginning of each year for 18 years, assuming an 8% rate of return, the account will have a value of $80,900.