Q. I have been contributing to Coverdell IRAs for my grandchildren for several years. It now seems apparent that they will all go to college and money for K-12 education will not be required. I am also contributing to 529 plans for all of them. Just to simplify the paperwork as I get older I’d like to get rid of the Coverdell IRAs. Do I have to cash these out to add to each of their 529 plans? If so, who pays the taxes and any penalties? Is there a way to roll the Coverdell IRAs directly into the 529 plan? Do you see any benefit to keeping the Coverdell IRA’s? I have 10 grandchildren so keeping up with 10 accounts would be much easier than my current 20!
A. Unless you think the grandchildren will need education-related funding before college I can’t think of a good reason to keep the Coverdell IRAs open. They have very low annual contribution limits (a maximum of $2,000) and any unused funds must be distributed once the beneficiary attains age 30 unless they are a special needs beneficiary. Funds distributed exceeding adjusted qualified educational expenses will be taxable to the beneficiary and usually subject to a 10 percent penalty.
The 529 plans allow for annual contributions up to the annual gift tax exclusion ($14,000). A higher contribution can be made using a special five year gift acceleration rule but it’s simpler if you keep your total annual gifts to one person at or under $14,000. There is no mandatory age for distributions from a 529 plan. You can change the beneficiaries to other family members, including yourself. Most plans even allow the money to be passed down and used to pay for college for the children of your grandchildren. Contact your current 529 plan and ask them if they have a special form to be used for incoming rollovers from a Coverdell IRA. This should be completed by you for each Coverdell IRA account (sorry, more paperwork) and then sent to the custodian of the Coverdell IRA. The IRA custodian will then send a check to the appropriate 529 plan account. Make sure the 529 plan administrator has a breakdown of the cost basis and earnings of the Coverdell being rolled into the 529 account. If the Coverdell custodian doesn’t provide this when completing the rollover, the information should be on your latest statement which can be sent to your 529 plan administrator. If this breakdown is not provided, the entire amount of the rollover will be deemed as earnings. Any earnings distributed and not used for higher qualified education expenses will be subject to income tax and a 10 percent penalty.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624