ISSUE ANALYSIS

a division of Home School Legal Defense Association
September 16, 2002

Education Savings Accounts

Emerging from the debate over school vouchers, education savings accounts (ESA) give parents choice in education without the accompanying strings of government regulation. The concept is similar to the increasingly popular Roth IRA: The government creates a tax incentive for parents to save for their children's K 12 education. As with the Roth IRA, taxes are paid up front on the contribution amount, but the interest accumulates tax-free.

Under the current ESA law parents or other individuals may contribute up to a total of $2,000 to a trust fund for a child. For example, a parent could contribute $500, a grandparent could contribute $1,000, and a local business could contribute $500 (total of $2,000) to the same account in one year. The money could then be invested through any combination of investments (mutual funds, stocks, bonds, etc.).

While the parent, grandparent, or business must still pay taxes on the original contribution, the interest that accumulates on the account is not taxed when it is withdrawn. However, the money must be used for qualified educational expenditures for public, private, and homeschools. In order to use the money for homeschooling expenses, the homeschool must be in compliance with applicable state law. Presently only thirteen states consider homeschools as private schools and five other states recognize groups of homeschoolers as private schools, but individual homeschools in these states do not qualify.

Qualified expenditures include tutoring fees, special needs services, books, supplies, and computer equipment, including related software and services.

Education savings accounts would give parents and concerned citizens a new way to invest in children's education from kindergarten through 12th grade. This incentive to save would benefit all students—public, private, and homeschool—by providing the resources children need to excel academically and encouraging parents and other interested adults to participate directly in each child's education.

The following is an illustration of how a family, by setting aside a specific amount every year in an education savings account, is able to invest in their child's education long-term. For this example let's say upon the birth of their first child, a couple invests $2,000 in an ESA — the maximum they can invest per child, per year. The parents then continue to deposit $2,000 each year until the child reaches the age of six, at which time the parents will have saved $12,000 of their own after-tax money. If their money has been compounding annually at 13% (imaginary percentage for this example) during that time, they will have earned $4,645.41 of tax-free money toward their child's education expenses. A little math demonstrates that the $4,645.41 in interest, divided by 12 years of education, would give parents approximately $387.12 per year to spend on their child's education. Note: This figure doesn't include the original after-tax $12,000 the couple deposited over the first six years of their child's life, which the parents could use to put towards their child's college education.

For more information on how to set up your own education savings account contact your local bank or an accountant or financial planner.