Coverdell Education Savings Accounts: Transferring Accounts and Changing Beneficiaries (page 3)
Just as in a Section 529 plan, you save in a Coverdell ESA for a day in the future: the day your child attends an educational institution that has some real dollar costs attached to it. Of course, for some, this day never arrives, and the money languishes in the account until the magic mandatory distribution to the designated beneficiary at age 30. For some, this may not be such a bad thing " you may feel that you saved the money for this particular person, and by the time that person has reached age 30, she is mature enough to manage the funds herself.
If you don't belong to that specific group and the thought of handing over all that money to that particular beneficiary sticks in your craw, you may want to explore whether you can change to a new designated beneficiary, taking the old one right out of the equation.
The designated beneficiary of a Coverdell ESA is the deemed owner of the assets in the account; however, he or she may not be the person named in the initial account-opening documents as being responsible for making the decisions regarding the account. If you're the named responsible adult, you're in luck, and you can initiate the transfer.
You may change the designated beneficiary on the same account as often as you like without incurring any tax or penalty; however, if you choose to roll one account over to another Coverdell account, changing the beneficiary at the same time, you're limited to one such tax-free rollover of the funds in that particular account in any given 12-month period.
Qualifying Relationships For Successor-designated Beneficiaries
In setting up a Coverdell account for your original beneficiary, you transfer all right, title, and interest in the money you gift into the account. Now, as the responsible adult named on the account, you're proposing taking that money away from your beneficiary. If you could do that without restriction, that would mean that you retained real control over the money. You don't, so you can't transfer to a new beneficiary without following the rules.
And the rules are quite simple. The new beneficiary must be related to the original beneficiary (not to you) in one of the following ways:
- A lineal descendent, such as a child, grandchild, or stepchild
- A lineal ancestor, including the beneficiary's mother, father, grandmother, grandfather, stepmother, or stepfather
- A brother, sister, stepbrother, or stepsister of the original beneficiary
- A niece or nephew (but no stepniece or stepnephew)
- An aunt, uncle, or first cousin of the original beneficiary (but no step- aunts, uncles, or cousins)
- A mother-in-law, father-in-law, sister-in-law, brother-in-law, daughter-in-law, or son-in-law
- The spouse of any of the people listed above, or of the original beneficiary
Maximum Age Of The Successor Beneficiary
All assets in Coverdell ESAs need to be totally distributed once the designated beneficiary reaches age 30. However, you do have the option of transferring the balance of the account to a new beneficiary just before that date, keeping the account open and operating well beyond the 30th birthday of the original designated beneficiary. So long as the new beneficiary is under 30 and falls within the acceptable range of family relationship to the original beneficiary, you can effect the transfer. If you choose a new beneficiary who is under age 18, you may even begin to make contributions into the account again.
Here's how it works: You begin to fund a Coverdell account for the first designated beneficiary, and continue making contributions until you're forced to stop when she reaches age 18. Suppose that this beneficiary then receives a full-paid scholarship and she doesn't need the funds, but you have another child, or even grandchild, who might benefit from the money you've saved. Instead of waiting and distributing the entire amount to the original designated beneficiary when she's 30, you choose to change beneficiaries and go with the younger child. Until that child reaches 18, you may make contributions into the account to the extent allowable by the governing rules.
Additional transfers of this nature can continue to be made using the same account, so long as the new beneficiary always is under 30 years old and is related to the original beneficiary in the manner described in the section "Qualifying relationships for successor-designated beneficiaries," earlier in this chapter. Whoever is the beneficiary when the account makes distributions is the person who pays income tax on the earnings, if any tax needs to be paid. Whoever is the beneficiary when excess contributions are inside the account is the one who must pay the excise tax on the excess contributions. And whoever is the beneficiary when the account finally terminates is the one who receives the final distribution and pays income tax on whatever income remains inside the account.
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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