Coverdell Rollover to 529?

Submitted by Jon Gates on Mon, 2025-02-03 12:48

Hey there, this might not be the appropriate place to ask this question, but I figured I would try anyway. I have two questions. First, can a Coverdell ESA be rolled over to a 529 for the same beneficiary? I have found mixed data on this topic. From my research, the consensus seems to be that it can be done, with rules similar to an IRA rollover. I.e. that the rollover has to be done within a 60 day window and needs to maintain the same beneficiary. I have also read that if it can be done as a custodian-to-custodian direct transfer. I even read that if the rollover is done with the same custodian, it is not reportable to the IRS?

Second question, if someone made contributions to a Coverdell account when they were actually over the AGI income limit (but didn’t know they shouldn’t have), and there are now substantial gains within the account, what are the options? Can this be rolled into a 529? Or does the account accrue the 6 percent excess penalty (similar to IRA Rules) and would this person need to pay the 6 percent penalty for the years that the funds have been in there, PLUS a 10 percent penalty, plus ordinary income tax on the gains?

Any insight would be appreciated, thank you!



Submitted by Alan - IRA critic on Mon, 2025-02-03 13:43

An ESA distribution can be rolled over to a 529 for the same beneficiary, but if this is done using a 60 day rollover, the one rollover per 12 month limit applies. Therefore, it may be preferable to do this by direct trustee transfers, which are unlimited in number and not reportable.

Excess ESA contributions are correct in the same manner as IRA excess contributions, and excess ESA amounts are not eligible for rollover to a 529, therefore this would just create an excess contribution to the 529.

Removal of excess amounts after the due date including extensions do not include the distribution of gains, so in exchange for the 6% excise tax, the gains can remain in the account. Therefore, the cost is limited to the excise tax plus possible interest for late payment of the excise taxes.

Submitted by Jon Gates on Mon, 2025-02-03 19:05

So let me see if I am understanding correctly, let’s use the actual scenario.

Client makes contributions to the coverdell ESA in 2013-2016. During those years, the client was single and his income was $200k per year which is over the acceptable MAGI. So if he contributed the max of $2k per year, there would’ve been $8k in total contributions. Then, let’s say that the account increased in value to $100k ($92k in gains).

Are you saying that the $92k of earnings are allowed to stay in the account and won’t be subject to tax or penalties (assuming it’s used for education expenses), BUT the $8k is subject to the 6% excise tax plus interest for all the years it has been sitting in there and shouldn’t have been?

And if that’s the case, that would mean the client could remove the $8k of contribution, plus pay the 6% excise tax plus additional interest, and then roll over the remaining $92k of earnings into a 529 for the same beneficiary. Am I understanding correctly?

Submitted by Alan - IRA critic on Mon, 2025-02-03 20:25

You understand correctly. Some states may even offer a state deduction for the 529 contributions funded from the ESA.  When paying the excise taxes with the 5329 forms, the IRS will have to determine the late interest charge and will bill it if they want to.

Submitted by Jon Gates on Mon, 2025-02-03 21:53

That is great news! Do you have any articles or reading material I can read to the client to support this?

Submitted by Jon Gates on Tue, 2025-02-04 15:31

Or can you direct me where I can go to confirm the information?

Submitted by Alan - IRA critic on Tue, 2025-02-04 17:24

It should be in Pub 970, but it isn’t. You could google “ascensus esa portability” for an article. The “saving for college.com” site should also address this.

Submitted by Jon Gates on Tue, 2025-02-04 19:25

Looking at the p970, I couldn’t find my exact scenario, but I did find this

Exceptions. The excise tax doesn’t apply if excess contributions made during 2024 (and any earnings on them)
are distributed before the first day of the sixth month of the
following tax year (June 1, 2025, for a calendar year taxpayer).
However, you must include the distributed earnings in
gross income for the year in which the excess contribution
was made. You should receive Form 1099-Q,

That sounds a bit like the earnings are subject to tax recognition when the excess earnings are distributed, am I understanding that incorrectly?

Submitted by Jon Gates on Wed, 2025-02-05 12:20

Can you confirm?

Submitted by Alan - IRA critic on Wed, 2025-02-05 18:06

Yes, the earnings are taxable for the year IN WHICH the excess contributions were made, but there is no 10% penalty.

Submitted by Jon Gates on Wed, 2025-02-05 18:20

Ok so the client needs to pay the 6 percent tax on the excess contributions, plus possible interest penalties. Then at the same time, the client would also have to pay taxes (ordinary income rates) on the gains that occurred the year of excess contribution?

What about all the remaining years of earnings? client stopped funding in 2016, and the accounts have been growing ever since. Will he have to pay tax on all the gains before he can roll the money into a 529?

If he is going to pay all 6 percent penalties and taxes, couldn’t he just take what’s left and put it in his bank account without the 10 percent penalty? I guess, what benefit would there be for doing a rollover to a 529?

Submitted by Jon Gates on Fri, 2025-02-07 14:09

Any thoughts on this would be amazing, thank you!

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