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Converting to a 529 from a Coverdell: pros and cons
http://www.savingforcollege.com/articles/20100723-converting-to-a-529-from-a-Coverdell-pros-and-cons

Posted: 2010-07-23 - Amy Buttell is a freelance writer based in Pennsylvania

by Amy E. Buttell

Coverdell Education Savings Accounts aren't exactly an endangered species. But as the years go by, they make less and less sense, especially when compared to their college savings siblings, 529 plans.

Coming changes in 2011 to Coverdell accounts render them even less useful, so now may be a good time to consider converting your Coverdell Plan to a 529 Plan, says Marilyn Plum, a Certified Financial Planner with Ballou Plum Wealth Advisors in Lafayette, Calif.

"For 2010, a Coverdell can still be used to pay expenses related to elementary or secondary school, which will be an issue for some folks this year," says Plum. "An IRS provision sunsets this year which, unless changed, will only allow Coverdells to be used for higher education after 2010. The annual contribution amount, now $2,000 a year, will reset to $500 a year, which is very limiting."

If you have kids in private elementary or secondary school, it makes sense to keep any Coverdell accounts to use them for those expenses this year. But beginning in 2011, unless Congress acts to change the law, it makes sense to convert, says Joe Hurley, founder of Savingforcollege.com. Hurley believes it is unlikely that Congress will vote to keep the K through 12 provision.

With those changes in mind, Plum says 529 plans offer many advantages over Coverdell plans. States have no annual contribution limits and many offer tax deductions for residents who contribute to their own state 529 plans, says Hurley. Five states do not restrict the deduction to their own plan. In fact, if you convert your Coverdell to a 529 plan and your state offers a tax deduction or credit, you may be able to claim the deduction for the entire amount of your conversion, Hurley says.

Plum agrees. "Coverdell accounts are pretty limiting for many consumers who want to save more," she says. "They don't compare favorably to 529 plans, which offer many advantages like being able to change beneficiaries. Although beneficiaries can be changed in a Coverdell account, some providers will deny such requests until the original beneficiary reaches age 18.

Despite the upcoming changes in laws governing Coverdell accounts, there's no hurry to convert unless you want to start enjoying the advantages of a 529 plan immediately, says Hurley. "The conversion option will remain in place regardless of what Congress decides to do about the law changes."

However, Plum says Coverdell funds must be spent by the time the beneficiary turns 30. If that does not happen, "any earnings would become taxable income and subject to a 10-percent, federal-tax penalty," she says. That problem can be avoided by a 529 plan conversion because the vast majority of 529 plans have no age limit.

If you decide to convert, here's how to do it:

  1. Pick a 529 plan. Before you initiate a conversion, you have to pick a 529 plan. For advice on how to pick a plan, check out Savingforcollege.com's College Savings 101 tutorial.

  2. Take a distribution from your Coverdell savings account. "You take a distribution from your Coverdell account as a qualified education expense, which includes the option of moving it to a 529 plan," says Plum. "The full amount in the Coverdell plan needs to go to the 529 plan during the same year to avoid a taxable event."

  3. Open a 529 plan account using the Coverdell distribution. There's some disagreement as to whether you should set up the new 529 plan with the Coverdell funds as a custodial 529 Plan or not. Hurley believes to be on the safe side, it makes sense to set up a custodial 529 plan.

"Coverdells are in some ways similar to Uniform Gift to Minors Act accounts because a Coverdell is a custodial account that needs to be used for the beneficiary of that account," Hurley says. "The IRS hasn't actually said that if you move money from a Coverdell, that it has to go into a custodial 529 plan account, but that makes sense to me."

Because of the lack of guidance from the IRS, Hurley says, "You should talk to your attorney before you decide how to handle the new account."

Posted July 23, 2010

Coverdell Education Savings Accounts aren't exactly an endangered species. But as the years go by, they make less and less sense, especially when compared to their college savings siblings, 529 plans.

Coming changes in 2011 to Coverdell accounts render them even less useful, so now may be a good time to consider converting your Coverdell Plan to a 529 Plan, says Marilyn Plum, a Certified Financial Planner with Ballou Plum Wealth Advisors in Lafayette, Calif.

"For 2010, a Coverdell can still be used to pay expenses related to elementary or secondary school, which will be an issue for some folks this year," says Plum. "An IRS provision sunsets this year which, unless changed, will only allow Coverdells to be used for higher education after 2010. The annual contribution amount, now $2,000 a year, will reset to $500 a year, which is very limiting."

If you have kids in private elementary or secondary school, it makes sense to keep any Coverdell accounts to use them for those expenses this year. But beginning in 2011, unless Congress acts to change the law, it makes sense to convert, says Joe Hurley, founder of Savingforcollege.com. Hurley believes it is unlikely that Congress will vote to keep the K through 12 provision.

With those changes in mind, Plum says 529 plans offer many advantages over Coverdell plans. States have no annual contribution limits and many offer tax deductions for residents who contribute to their own state 529 plans, says Hurley. Five states do not restrict the deduction to their own plan. In fact, if you convert your Coverdell to a 529 plan and your state offers a tax deduction or credit, you may be able to claim the deduction for the entire amount of your conversion, Hurley says.

Plum agrees. "Coverdell accounts are pretty limiting for many consumers who want to save more," she says. "They don't compare favorably to 529 plans, which offer many advantages like being able to change beneficiaries. Although beneficiaries can be changed in a Coverdell account, some providers will deny such requests until the original beneficiary reaches age 18.

Despite the upcoming changes in laws governing Coverdell accounts, there's no hurry to convert unless you want to start enjoying the advantages of a 529 plan immediately, says Hurley. "The conversion option will remain in place regardless of what Congress decides to do about the law changes."

However, Plum says Coverdell funds must be spent by the time the beneficiary turns 30. If that does not happen, "any earnings would become taxable income and subject to a 10-percent, federal-tax penalty," she says. That problem can be avoided by a 529 plan conversion because the vast majority of 529 plans have no age limit.

If you decide to convert, here's how to do it:

  1. Pick a 529 plan. Before you initiate a conversion, you have to pick a 529 plan. For advice on how to pick a plan, check out Savingforcollege.com's College Savings 101 tutorial.

  2. Take a distribution from your Coverdell savings account. "You take a distribution from your Coverdell account as a qualified education expense, which includes the option of moving it to a 529 plan," says Plum. "The full amount in the Coverdell plan needs to go to the 529 plan during the same year to avoid a taxable event."

  3. Open a 529 plan account using the Coverdell distribution. There's some disagreement as to whether you should set up the new 529 plan with the Coverdell funds as a custodial 529 Plan or not. Hurley believes to be on the safe side, it makes sense to set up a custodial 529 plan.

"Coverdells are in some ways similar to Uniform Gift to Minors Act accounts because a Coverdell is a custodial account that needs to be used for the beneficiary of that account," Hurley says. "The IRS hasn't actually said that if you move money from a Coverdell, that it has to go into a custodial 529 plan account, but that makes sense to me."

Because of the lack of guidance from the IRS, Hurley says, "You should talk to your attorney before you decide how to handle the new account."

Posted July 23, 2010

 

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