Entrust Learning Center > Keyword: self directed ira > Coverdell Education Savings Account (CESA)

Coverdell Education Savings Account (CESA)

The Coverdell Education Savings Account (CESA) became effective January 1, 1998.

The Coverdell Education Savings Account is an account established by an authorized person (generally a parent or guardian) for the benefit of a minor.

1. The Contributor may be any individual, even a person not related to the Beneficiary.
   
2. The Designated Beneficiary may even contribute for themselves since there is no earned income requirement to make an Coverdell Education Savings Account contribution.
   

Contributions are not deductible, but earnings, can be tax free if used for qualified higher education expenses, when withdrawn.

Eligibility Requirements

There are four main parties involved in a CESA. These parties all have eligibility requirements.

1. Grantor or Depositor

Generally, any individual is eligible to establish and contribute to an ESA on behalf of a designated beneficiary provided the contributing individual’s income falls below certain income thresholds. This individual establishes the account on behalf of the Designated Beneficiary.

Income Criteria

2. Designated Beneficiary

The designated beneficiary is the individual who may use the assets for educational purposes.

3. Responsible Individual

The responsible individual is generally a parent or legal guardian of the designated beneficiary. However, Entrust permits someone other than the designated beneficiary’s parent or legal guardian to serve as the responsible individual. This individual may serve as the responsible individual as long as he or she is not prohibited by law, and provided the individual is able to fulfill on the ESA plan agreement upon establishment. Under certain circumstances, the designated beneficiary may become the responsible individual of his or her own ESA.

The responsible individual is that individual who has the power to redirect the initial investments, direct the investment of all additional contributions, and generally directs the financial organization regarding administration, management, and distribution of the account.

4. Death Beneficiary

A designated death beneficiary is described as the individual(s) or entity(ies) intended to receive the ESA funds upon death of the designated beneficiary. ESA assets must generally be distributed within 30 days after the date of death of the designated beneficiary to the designated death beneficiary. However, a designated death beneficiary who is a qualified family member under the age of 30 may treat the ESA as his or her own following the death of the designated beneficiary.

Contribution Amount and Eligibility

The Contributor can make after tax contributions of up to $2000 per child until the date of the beneficiary’s 18th birthday. (These can be made in addition to regular IRA or Roth IRA contributions). No minor can receive more than $2000 in contributions to an Coverdell Education Savings Account regardless of the number of Coverdell Education Savings Accounts for which he or she is the beneficiary.

Contribution Deadline

The contribution deadline for an individual is the tax return due date for the taxable year, not birthday.

Distributions

General Taxation Rules

Distributions are generally tax free if made for qualified higher education expenses, provided that a HOPE or Lifetime Learning Credit is not claimed with respect to the Beneficiary for the same taxable year. The definition of higher education expenses is fairly broad and covers:

a) Tuition fees
b) Books
c) Supplies and equipment required by the college or university
d) Room and board (if the student is enrolled on at least a half-time basis).

Distributions that are not used for qualified higher education expenses are treated as representing a pro-rata share of the basis (i.e., contributions) and accumulated earnings in the account.

1. 10% penalty

The taxable portion of a Coverdell Education Savings Account distribution is subject to an additional 10 percent penalty tax unless the distribution is:

1. Made to the estate of a designated beneficiary following his or her death,
2. Made to the designated beneficiary on account of disability, or
3. Made on account of scholarship, allowance or payment received by the beneficiary to the extent that the amount of the payment does not exceed the amount of the scholarship, allowance or payment.

Special Rules

1. Rollovers
To qualify as a rollover, amounts must be placed in a Coverdell Education Savings Account of an eligible individual within 60 days after the date of the distribution. The $2000 annual contribution limit to Coverdell Education Savings Accounts does not apply to rollover contributions.

Only one rollover is permitted per Coverdell Education Savings Account per 12 month period.

2. Transfers
The statute specifically addresses the ability to conduct a transfer between ESAs only under special rules relating to the death and divorce of the designated beneficiary. How ever, the Conference Committee reports indicate that it was Congress’s intent to allow tax-free and penalty-free movement of money between ESAs under other circumstances.

Beginning with 2003 reporting, trustee -to-trustee transfers (as well as rollovers) are a reportable event. The transfer is reported as a distribution on Form 1099-Q and the transfer contribution is reported on Form 5498-ESA , Coverdell ESA Contribution Information.

However, IRS officials verbally confirmed that transfers within the same financial organization, which occur if changing the name of designated beneficiary on an ESA or transferring ESA assets to a qualified family member’s ESA within the same financial organization, are not reportable events.

3. Changing the Designated Beneficiary
If the grantor/depositor so elects on the plan agreement, the responsible individual of the ESA may change the designated beneficiary provided that the new designated beneficiary is a qualified member of the family of the original designated beneficiary. The qualified family member must generally be under the age of 30.

Qualified family members include:

1. The spouse of the designated beneficiary;
2. The son or daughter of the designated beneficiary, or a descendant of either;
3. A stepson or stepdaughter of the designated beneficiary;
4. A brother, sister, stepbrother, or stepsister of the designated beneficiary;
5. The father or mother of the designated beneficiary, or an ancestor of either;
6. A stepfather or stepmother of the designated beneficiary;
7. A son or daughter of a brother or sister of the designated beneficiary;
8. A brother or sister of the father or mother of the designated beneficiary;
9. A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law of the designated beneficiary;
10. The spouse of any individual describe above in items 2-9; or
11. A first cousin of the designated beneficiary.

4. Special Needs Individuals
There are numerous exceptions to all rules for individual meeting the definition of special needs.

IRS Reporting Requirements

1. Form 1099-Q Reporting Requirements – Distributions

The ESA reporting requirements as released in the instructions to the Form 1099-Q instructions to the Form 1099-Q are summarized below.

1. Box 1 shows the gross distribution amount for an ESA.
2. Box 2 shows the earnings portion of the amount in box 1.
3. Box 3 shows the basis portion of the amount in box 1.
4. Box 4 is checked if the amount in box 1 was directly transferred from an ESA to another ESA.
5. Box 5 is checked to indicate reporting for a Coverdell ESA.
6. Box 6 is checked if the recipient of the distribution is not the designated beneficiary of the distributing ESA.
   

2. Requirements If Not Reporting Earnings and Basis
Under the provisions of Notice 2003-53, in the event that a financial organization is unable to calculate and report earnings (Box 2) and basis (Box 3), Form 1099-Q is to be completed in the following manner.

1. Report the gross distribution in Box 1.
2. Complete all boxes of Form 1099-Q except Boxes 2 and 3 (unless the gross distribution includes a distribution of earnings on excess contributions).
3. Box 4, Trustee-to-trustee transfer, may be left blank if the financial organization’s records do not indicate whether or not the distribution represents a direct trustee-to-trustee transfer of assets.
4. Complete all boxes of Form 1099-Q except Boxes 2 and 3 (unless the gross distribution includes a distribution of earnings on excess contributions).
5. Box 4, Trustee-to-trustee transfer, may be left blank if the financial organization’s records do not indicate whether or not the distribution represents a direct trustee to-trustee transfer of assets.
6. If the distribution represents the correction of an excess ESA contribution, report the gross amount in Box 1 and the earnings (calculated according to the IRA excess contribution/NIA formula) in Box 2.
7. In the blank area beneath Boxes 5 and 6, enter an indication that the amounts in Box 2 represent earnings on an excess contribution, if applicable, the fair market value of the account as of December 31 of the reporting year and appropriately label it as such, an a reference to IRS Publication 970, Tax Benefits for Education, as a source of help in determining the basis and earnings of an ESA distribution. (Form 1099-Q includes this reference on Copy B, which is distributed to the recipient.)
   

3. IRS Form 5498-ESA – Contributions
Contributions (including rollovers and trustee-to-trustee transfers) are reported on Form 5498-ESA, Coverdell ESA Contribution Information. The FMV is not reported on Form 5498-ESA, and an IRS official confirmed that the FMV is not required to be reported for ESAs.

4. IRS Reporting Timelines for CESAs

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