If you've finished college but you still have funds in your Coverdell Education Savings Account, also known as an Education IRA, it's time to start thinking about what to do with the extra money. If you cash out the account you may end up owing taxes, but you also can roll the funds over at any time to a sibling or other relative, preserving the fund's tax-free growth potential.
A Coverdell ESA is a type of growth fund in which the earnings are never taxed, as long as you use the money for qualified educational expenses. The accounts originally were known as Education IRAs, even though they had nothing to do with retirement. The program was renamed in 2002 after Congress increased the annual contribution limit and allowed participants to spend the money on elementary and secondary education in addition to college.
If there's money in the fund when you reach 30, you must either take the money out and pay taxes on the earnings, or roll the account over to a relative within 30 days. You can initiate a rollover at any time -- you don't have to wait until you turn 30. Once you take money out of a Coverdell account, you have 60 days to deposit the money into a relative's Coverdell account without any tax penalties. As an alternative, you can roll over the entire amount in the fund by simply changing the name on the account. You can initiate only one rollover every 12 months, so if you plan to distribute to funds to more than one relative, a little advanced planning may be needed.
The list of relatives who can receive a Coverdell rollover is quite large. It includes your spouse and children or foster children, a brother or sister, a niece or nephew, an aunt or an uncle, or any of their spouses. First cousins and in-laws are also included. Even parents can roll the money over from their child's account to pay for their own school costs.
If you don't roll over any leftover funds within 30 days of turning 30 years old, you will have to pay normal income taxes on the earnings, plus an additional 10-percent penalty. Your bank will send you a Form 1099-Q, Payments from Qualified Education Programs, that lists the amount of the amount of earnings subject to taxes and penalties.
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