Know These Steps When Opening a Coverdell ESA
Contributions to Coverdell education savings accounts (ESAs) tend to pick up around the holidays and at the start of a new year, as some parents and grandparents choose to set up an ESA to help the children in their lives save for future education expenses. While your organization may welcome the additional revenue, if you do not work with ESAs on a regular basis, a review of how to establish an ESA may be helpful.
Follow certain steps to ensure that an ESA is correctly set up.
1. Complete accurate, up-to-date opening documents.
An ESA must be established with a written plan agreement that names the child, referred to as the “designated beneficiary,” for whom the ESA is established. Financial organizations should provide the appropriate parties with a disclosure statement as a display of good customer service. But neither a disclosure statement nor a financial disclosure, like that used for IRA establishment, is actually required for an ESA.
Your financial organization may use one of the following types of documents to satisfy the plan agreement requirement.
IRS model document Form 5305-E, Coverdell Education Savings Trust Account, or Form 5305-EA, Coverdell Education Savings Custodial Account
Standardized document kit (application, plan agreement, and disclosure statement) from a forms provider
Custom-designed document
Forms providers, like Ascensus, provide ESA plan documents that generally are based on IRS model plan agreements, but also include disclosure statements and other information.
If not using a forms provider disclosure statement, IRS Publication 970, Tax Benefits for Education, may serve as a disclosure statement.
Naming a death beneficiary is not an IRS requirement, but death beneficiaries generally can be named on the ESA application or a designation of beneficiary form. The financial organization should keep the beneficiary document on file.
2. Obtain required signatures.
The IRS requires that an ESA document be signed by the ESA administrator (a financial organization representative) and by the grantor/depositor, who is the person that establishes the ESA for the child’s benefit. The grantor/depositor will name a responsible individual to manage the ESA on the child’s behalf. The IRS does not require the responsible individual’s signature, but it may be required if prescribed by the document. Obtaining the responsible individual’s signature is highly recommended, as it confirms their willingness to fulfill that role.
3. Provide copies of opening documents to appropriate parties.
Plan agreement and disclosure statement copies must be given to the grantor/depositor who establishes the account. But financial organizations should provide copies to the responsible individual as well. Note that the grantor/depositor often is the responsible individual named on the ESA document.
4. Retain signed, dated copy of plan agreement.
To prove that the plan agreement was received, an ESA grantor/depositor should sign and date a copy of the plan agreement or an acknowledgment that he received a copy of the plan agreement. Often the acknowledgment is found in the signature section on the ESA application. The signed copy or acknowledgment should be retained in the designated beneficiary’s file or an electronic storage system as the required proof. Some ESA plan agreements may also require the responsible individual’s signature to acknowledge receipt of the plan agreement.
5. Amend opening documents when applicable.
While there is no written guidance requiring ESA amendments for law changes, most financial organizations find it helpful to amend to the latest ESA plan documents whenever important statutory or regulatory events take place. This practice keeps clients informed of the latest rules affecting ESAs.
When amending ESA documents, financial organizations generally should follow these steps.
1. Obtain the updated ESA plan agreement and disclosure statement, if applicable.
2. Provide the amendments to the responsible individual. ESA document language or business procedures may dictate that amendments also be provided to the designated beneficiary or the grantor/depositor.
3. Place a copy of each amendment in the designated beneficiary’s file or retain a single copy of the amendment and accompanying cover letter in a master file with a list of all the designated beneficiaries and responsible individuals who received the amended documents.
Typically, forms providers amend ESA documents as necessary and timely facilitate these amendments with their clients.
ESA Contribution Limit
The individual establishing the ESA is typically the first to make a contribution. The annual contribution limit is $2,000. Note that the limit is per designated beneficiary, not per ESA. An individual may be named as the designated beneficiary of more than one ESA, but the total contributions made on behalf of that person for the year cannot exceed $2,000.
Contributions can be made until the beneficiary turns 18. If a designated beneficiary is a special needs beneficiary, she may continue to receive ESA contributions after age 18.
