Under current law, 529 plans offer tax-free investment income, if the money is spent on higher education. Thus, a 529 plan cannot provide tax-free earnings for private elementary or high schools.
If you are interested in private school for your children or grandchildren, a Coverdell education savings account (ESA) might be appropriate. Formerly known as education IRAs, Coverdell ESAs can accept annual contributions up to $2,000 per student, up from $500 in years prior to 2002.
Money held in a Coverdell ESA will be available to pay all types of education expenses, beginning in kindergarten. Thus, money can be withdrawn to pay private school bills. Coverdell ESAs can be used, tax-free, for a wide variety of educational expenses, including tutoring (such as prep courses for standardized tests) and software.
Unlike Section 529 plans, there are income limits for making contributions to a Coverdell ESA. Married couples with adjusted gross income (AGI) over $220,000 are excluded while those in the $190,000-$220,000 range can contribute less than the $2,000 maximum. (For single filers the numbers are exactly half, $95,000 and $110,000.)
In practice, this may not make much difference because any number of people can contribute to your child’s Coverdell ESA. If you and your spouse are over the limit, you might ask each of four grandparents to put in $500 per child per year, assuming they file jointly, with AGIs under $190,000.
