Terminating ESAs at Age 30

By Kristiana Rodriguez

One unique feature to a Coverdell Education Savings Account (ESA) is the requirement that the account terminates when the designated beneficiary reaches age 30. If you don’t stay on top of these accounts, you risk not reporting them correctly to the IRS and possibly losing contact with the designated beneficiary. It’s important to establish a process that will help you keep track of ESA clients and any major milestones that could affect their ESAs.

Important ESA Milestones

Birth to age 18: ESAs may be funded for a child under age 18*

School age to age 18: Contributions accepted and distributions for qualified education expenses allowed

Age 18 to 30: Distributions for qualified education expenses allowed, and transfers/rollovers to eligible family member

30 days after attaining age 30: ESA assets must be distributed or moved to an eligible family member*

* The age requirements for contributions and termination do not apply for individuals with special needs.

At age 30, the designated beneficiary must do one of two things with any remaining assets in the ESA: distribute the assets or transfer or roll over the assets to a qualified family member’s ESA. Either option must be done within 30 days of the designated beneficiary turning 30. The age 30 restriction is waived for designated beneficiaries with special needs. “Special needs” is not yet defined in official IRS guidance, but the intent of Congress is to include individuals who require additional time to complete their education because of physical, mental, or emotional conditions (including learning disabilities).

Transferring or Rolling Over ESA Assets to a Qualified Family Member

If it is determined that the designated beneficiary of an ESA will not be using the ESA assets for qualified education expenses, or for other reasons, the ESA’s responsible individual may be able to transfer (or roll over) ESA assets to a qualified family member’s ESA. Any restrictions on the ability to make such a transfer will generally be defined by the ESA document. If this is permitted, you will want to follow your organization’s usual procedures to open an ESA for this qualified family member, if one does not already exist.

Eligible family members include the designated beneficiary’s

child or descendent of the child, stepchild, or eligible foster child,
spouse,
brother, sister, stepbrother, or stepsister,
father, mother, stepfather, or stepmother,
aunt or uncle,
niece or nephew,
son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law,
a spouse of any of the individuals named above, or
a first cousin.

The new designated beneficiary must be under the age of 30. The age 30 restriction may be waived for a special needs beneficiary.

Transfer

If ESA assets are internally transferred within your organization, you will not report the transfer. If assets are transferred to another financial organization, your organization must report the transfer on Form 1099-Q, Payments From Qualified Education Programs, in Box 4, Trustee-to-trustee transfer. There is no limit to the number of trustee-to-trustee ESA transfers permitted.

Rollover

The IRS model ESA documents require the grantor/depositor to elect whether the responsible individual may or may not change the designated beneficiary “under this agreement” to another qualified member of the designated beneficiary’s family. Some service providers’ documents provide a default if an affirmative election is not made. Although it was first thought that an election prohibiting the responsible individual from changing the designated beneficiary would also prevent the responsible individual from rolling over assets from one designated beneficiary to another, the IRS has indicated informally that restricting rollovers between qualified family members was not its intent, though official guidance on this topic has not been released. If asked to complete a rollover between ESAs of qualified family members when the ESA document prohibits the responsible individual from changing the designated beneficiary on an account, proceed cautiously.

ESA rollovers must be completed within 60 days after the date of the distribution. Unlike IRAs, the IRS does not waive the 60-day limitation for ESA rollovers due to certain extenuating circumstances. Only one ESA rollover per 12 months is allowed. This 12-month period begins the day after the individual receives the distribution. To report the rollover, the distributing financial organization must report the distribution in Box 1, Gross distribution, on Form 1099-Q. The organization receiving the assets must enter the rollover amount in Box 2 of Form 5498-ESA, Coverdell ESA Contribution Information.

Deemed Distributions

If assets are still in the ESA on the 30th day after the designated beneficiary turns 30, the tax laws treat the ESA assets as being distributed to the designated beneficiary on the 30th day. Financial organizations must report this deemed distribution on Form 1099-Q. Any subsequent distribution of the account should not be reported. Forms 5305-E, Coverdell Education Savings Trust Account, and 5305-EA, Coverdell Education Savings Custodial Account, state, “any balance to the credit of the designated beneficiary on the date on which he or she attains age 30 shall be distributed to him or her within 30 days of such date.” Most ESA plan agreements allow financial organizations to distribute the remaining balance within 30 days of the designated beneficiary’s 30th birthday. An attempt to contact the responsible individual also could be made. Review your organization’s disclosure statement for procedures outlined for making these distributions. (Note: in certain special-needs beneficiary circumstances, the ESA is not automatically deemed distributed in this manner.)

Once the ESA assets have been reported as distributed on Form 1099-Q, the designated beneficiary will be subject to both income tax and additional 10 percent penalty tax on the portion of the distribution that represents earnings, if the designated beneficiary does not have any qualified education expenses in that year. Any subsequent distributions from that account should not be reported.

Escheating Funds

Given the rules regarding terminating an ESA at age 30, funds should not remain in an ESA indefinitely. If you still hold such assets you should follow your organization’s procedures regarding escheating accounts.

Escheat laws give each state rights to unclaimed or abandoned property. Because escheat laws are governed at the state level, each state has its own timeline; three, five, and seven years are common escheat periods. Check with your financial organization’s legal counsel for specific escheatment procedures.