When to consider a Coverdell ESA to 529 plan rollover
Up until recently, the Coverdell ESA was the only tax-advantaged account designed to save for elementary and high school expenses. But the Tax Cuts and Jobs Act in 2017 expanded the definition of 529 plan qualified higher education expenses to include up to $10,000 per year in K-12 tuition, giving families another option.
A Coverdell ESA works very similar to a 529 savings plan – individuals contribute after-tax dollars, which grow tax-deferred and aren’t taxed when withdrawn to pay for qualified higher education expenses (QHEE) or qualified elementary and secondary education expenses (QESEE). QESEE for a Coverdell ESA include tuition and fees, books, supplies and equipment, academic tutoring and special needs services for beneficiaries living with a disability.
You should consider a Coverdell ESA to 529 plan rollover if:
Your income has risen, or you expect it to rise
Unlike 529 plans, Coverdell ESAs have income limits. If your adjusted gross income (AGI) is greater than $110,000 ($220,000 if married and filing jointly), you are not eligible to contribute to a Coverdell ESA. If your AGI falls between $95,000 and $110,000 ($190,000 and $220,000 if married filing jointly), your annual contribution limit will be reduced. The income limits for Coverdell ESAs do not change.
You want to save more than the annual $2,000 per beneficiary limit
Coverdell ESAs allow you to save up to $2,000 per year, per beneficiary. Yet according to the Private School Review, the average tuition cost for a private school in the U.S. is just over $10,000 per year. 529 plans do not have an annual contribution limit, other than the annual gift tax exclusion.
You may contribute to both a Coverdell ESA and a 529 plan at the same time, so long as the combined annual contribution is less than the annual gift tax exclusion amount.
A relative has a separate Coverdell open for your child
The contribution limit for a Coverdell ESAs is per beneficiary, not per account. That means if a parent and a grandparent have an account for the same child, the sum of contributions to both accounts must be less than $2,000 per year. Anything above the limit will be subject to a 6% excise tax.
You want more flexibility
if the beneficiary of a Coverdell ESA is not a special needs beneficiary, contributions must end when the beneficiary turns 18 and funds must be spent by the time the beneficiary turns 30. If your child decides not to go to college or has leftover funds in the account, you will have to change the beneficiary to another child who is a qualifying family member or take a non-qualified withdrawal. With a 529 plan, parents have the option of making themselves the beneficiary and using the funds to further their own education or saving the money for a future grandchild without any age or time limits.
You might have leftover money in the account after the beneficiary finishes college
Funds in a Coverdell ESA must be spent by the time the beneficiary turns 30.
Your Coverdell ESA has high fees
Coverdell ESAs tend to have smaller balances, which means you could end up paying more in fees. If this is the case, you may want to explore a 529 plan that offers low-cost investment options.
Your state offers a 529 tax benefit
In addition to federal tax savings, over 30 states offer a tax credit or deduction for 529 plan contributions. For example, a married couple in Indiana who contributes $200 a month to an in-state 529 plan is eligible for $360 in annual tax savings. Coverdell ESAs do not offer any state income tax benefits, but some states allow rollover contributions from a Coverdell ESA to a 529 plan to qualify for state income tax benefits.
How to rollover a Coverdell ESA to a 529 plan
- Select a 529 plan and appropriate investment options. 529 plans can be opened directly or through a financial advisor, and you can enroll in almost any state’s 529 plan no matter where you live. Most plans offer age-based investment portfolios, which automatically shift allocations over time based on the age of the beneficiary, or static portfolios where the asset allocation remains the same over the life of the account.
- Withdraw the funds from your Coverdell ESA. Distributions used to fund a 529 plan are considered a qualified expense as long as both accounts have the same beneficiary.
- Enroll in a 529 plan and fund the account with your Coverdell ESA distribution within 60 days. You may want to consider setting up a custodial 529 account, since the original Coverdell ESA was established for the benefit of the child.
A Coverdell ESA to 529 plan rollover may be done as a trustee-to-trustee transfer. If done as a trustee-to-trustee transfer, there is no limit to the number of Coverdell ESA transfers that may be made for a designated beneficiary.
A good place to start