Unspent Coverdell ESA options are limited


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Dear Dr. Don,
I have a Coverdell Education Savings Account for my son. He’ll be graduating college soon but will not have exhausted the Coverdell account. Although he attended a private high school, we didn’t tap the funds at the time. Can the remainder of his funds be used for “reimbursement” of his high school tuition and therefore be “qualified” expenses and tax-free?

— Shannon Scenario

Dear Shannon,
Sorry. That’s not how the IRS rolls when it comes to using these tax-advantaged accounts for qualified education expenses. If graduate school is a possibility, then he has until age 30 until the funds must be distributed out of the account.

Another possibility would be to change the beneficiary to a family member under the age of 30. IRS Publication 970, Tax Benefits for Education, addresses the issue.

Here is some guidance from that publication:

Any amount distributed from a Coverdell ESA is not taxable if it is rolled over to another Coverdell ESA for the benefit of the same beneficiary or a member of the beneficiary’s family (including the beneficiary’s spouse) who is under the age of 30. This age limitation does not apply if the new beneficiary is a special needs beneficiary. An amount is rolled over if it is paid to another Coverdell ESA within 60 days after the date of the distribution.

For these purposes, the beneficiary’s family includes a spouse and the following other relatives of the beneficiary.

  1. Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them.
  2. Brother, sister, stepbrother or stepsister.
  3. Father or mother or ancestor of either.
  4. Stepfather or stepmother.
  5. Son or daughter of a brother or sister.
  6. Brother or sister of father or mother.
  7. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law.
  8. The spouse of any individual listed above.
  9. First cousin.

With some exceptions for military members, there is a limit of one rollover per Coverdell ESA during the 12-month period ending on the date of the payment or distribution.

There may be gift tax ramifications associated with the change of beneficiary. With a $14,000 annual exclusion for gift taxes in 2014 and the ability to spread a gift of more than that amount over five years, there should be a way to make this work. Consider working with a tax professional, if needed.

Alternately, moving the money from a Coverdell ESA to a 529 plan can provide more options for your son. As the publication referenced earlier put it, “A contribution to a QTP (529 plan) is a qualified education expense if the contribution is on behalf of the designated beneficiary of the Coverdell ESA.”

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