How Retirees Can Fund an Education Savings Account with Their RMD

By Sarah Brenner, IRA Technical Expert
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Are you retired and taking required minimum distributions (RMDs) from your traditional IRA? While many retirees need those RMDs for living expenses, medical care and other needs, some don’t. There are many IRA owners who don’t want to take RMDs because they don’t need the money. Here is a surprising suggestion if that is your fortunate situation. Consider contributing your RMD to an Education Savings Account (ESA) to help save for a child’s education expenses.

You may establish an ESA with the custodian of your choice and the paperwork you complete is very similar to the paperwork necessary to establish an IRA. When you establish the ESA, you will need to name a responsible individual.  The responsible individual controls the ESA, including investment choices and when distributions are taken. Many custodians will allow you, as the contributor, to name yourself as the responsible individual. Contributions are made to the account to help save for education expenses of a designated beneficiary. The designated beneficiary is a child under the age of 18.

Contributions may be made for designated beneficiaries older than 18 only if they have special needs. The maximum contribution amount is $2,000 per year for each designated beneficiary, but you may contribute that amount to ESAs for multiple beneficiaries. For example, if you have three grandchildren, you could contribute $2,000 each year to each of their ESAs. There are income limits for contributing to an ESA. If your income is above them, you might consider giving the funds to the child or another person with income under the limits and having them make the contribution to avoid those limits.

There are no age limits for making an ESA contribution and there is no earned income or taxable compensation requirement to contribute to an ESA. Retirees who are no longer working are, therefore, able to make these contributions. The contribution deadline is generally the tax-filing deadline, April 15. If you decide to fund an ESA with your RMD, the RMD will still be taxable to you in the year the distribution is paid, unless it is a return of after-tax contributions.

Your ESA contribution is not deductible but the earnings will be tax-free if the funds are used to pay for qualified education expenses. The definition of qualified education expenses is very broad for ESA purposes. Qualified education expenses include college tuition, room and board as well as required books and supplies. The student can be a full time or part time student. Vocational school or community college expenses are included as well. You are not limited to expenses after high school graduation.

An important benefit of an ESA is that tax-free distributions may be taken for primary and secondary expenses. These include tuition, fees, tutoring and special needs services expenses incurred in connection with enrollment of the designated beneficiary at a public or private school. Also included are computer and Internet expenses as long as the designated beneficiary and family uses the technology during a year when the designated beneficiary is in school. If the distribution is not used for education expenses, the earnings portion will be taxable to the designated beneficiary and may be subject to a 10% penalty unless an exception applies.

Funds may also be rolled over to an ESA for a member of the designated beneficiary’s family who is under age 30. If the child’s parents are already funding a qualified tuition plan or 529 plan, you still can fund an ESA as well. ESA funds are even eligible to be rolled over to qualified tuition plans. (We have written A LOT about 529 plans for college, including why a Roth IRA may be a better vehicle.)

Education is expensive these days. Why not use every tool available to handle these costs? If you are receiving RMDs and don’t need the funds for your own expenses, using your RMD to fund an ESA for a child you care about may be an interesting option to explore with your tax advisor.


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