Coverdell Education Savings Accounts: Transferring Accounts and Changing Beneficiaries (page 2)

By — John Wiley & Sons, Inc.
Updated on Jul 26, 2010

Rolling Over Coverdell Accounts

In addition to changing the designated beneficiary on an account, if you're the responsible adult on an account, you may also choose to move from one Coverdell account to another, either for the same beneficiary or for a new one (but one who fulfills all the requirements).

You may make an account rollover by withdrawing funds from your current account, and then, within 60 days, depositing them into a new Coverdell account. You need to keep track of the dates; if you wait until the 61st day, you make a nonqualified distribution, and the designated beneficiary on your first account is responsible for income tax on the earnings plus a 10 percent penalty. In addition (and not to scare you), you're also handing the control over that money to that beneficiary — good luck trying to retrieve it.

Transferring Into A Section 529 Plan

Although you're limited by beneficiary age within a Coverdell account, Section 529 plans have no age limitations. Accordingly, you may want to make a tax-free transfer from the Coverdell account into a Section 529 plan for the same designated beneficiary before that beneficiary turns age 30. Transferring from a Coverdell account to a Section 529 plan gives rise to some interesting consequences, though, so you want to be careful.

When you initiate a transfer from a Coverdell account, the account trustee or custodian will write a check to your designated beneficiary, not to the new account. If you choose to have those exact funds go into the Section 529 plan, the 529 plan it goes into needs to have your designated beneficiary listed as the account owner. When you contribute to a Coverdell account, you make a completed gift to your student; you may not take it back.

If giving Baby Alex control over a Section 529 plan gives you the heebie-jeebies, consider making a contribution directly into a 529 plan, using an equivalent amount of your funds rather than the proceeds from the Coverdell account. You must deposit your funds within 60 days after making the withdrawal from the Coverdell account. By funding the 529 plan with your own funds, you retain control over the 529 plan as the account owner; you've also fulfilled the rollover requirement of completing the transfer within 60 days. The proceeds from the Coverdell withdrawal now belong to your designated beneficiary (over whose assets you still have control until he or she reaches age 18), and the new 529 assets remain under your control.

If you choose to fund a Section 529 plan with your own funds but you're not able to put the full amount that was in the old Coverdell ESA into the new 529 plan, your designated beneficiary pays income tax and penalties on the income earned on the amount of the distribution that isn't being rolled over.

Neither scenario is perfect, in that they allow control over money to pass to your designated beneficiary, either by making her the account owner on a Section 529 plan or by actually handing her the cash. Still, if the amounts are not huge or if your designated beneficiary is incredibly mature for her age, it may work for you.

Transferring Due To Divorce

When planning for your student's education, you're probably not imagining a time when your designated beneficiary will be old enough to think about any marital issues, especially a marital dissolution. After all, you probably set up this account when your child was just a kid, and the first thought that crosses your mind when you check on him asleep in his bed is not how he's going to divide his assets when he gets a divorce.

Still, a Coverdell ESA can live on well into adulthood, and it may still be an asset owned by your designated beneficiary after he marries, and even at the time of a divorce. If this happens to your student, there are some things you both should know:

  • Coverdell ESAs aren't counted as community property in community property states. Funds are gifted directly to the owner of the account (even if the gifts occur after marriage through a tax-free rollover from a different Coverdell ESA) and are maintained solely for the benefit of the account owner.
  • The owner of the account may include a Coverdell ESA as part of the divorce or separation agreement, transferring ownership to his or her spouse or former spouse. In this case, provided the new owner is under age 30, this is a tax-free transfer, even if another tax-free transfer or rollover occurred within the last 12 months.
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