A Coverdell education savings account is no longer known as an individual retirement account (IRA), even though the rules for contributing to a Coverdell are similar to those for contributing to a Roth IRA. While you can convert a traditional IRA to a Roth IRA, you cannot convert an IRA to a Coverdell account, since they do not perform the same function.
You can set up a Coverdell account for a beneficiary. The beneficiary must be under age 18, and contributions are not allowed to the account after the beneficiary turns 18. Up to $2,000 per year may be contributed per beneficiary, as of 2011, unless the account holders earn more than $95,000 a year if single, or $190,000 if married and filing jointly. Those earn more than $110,000 or $220,000 cannot contribute at all. The money in a Coverdell must be used for education. Any money left in the account when the beneficiary turns 30 must be taken out and a penalty tax paid on it, or rolled over into another Coverdell for another beneficiary.
Converting an IRA
Although technically you can't transfer funds from a traditional or Roth IRA to a Coverdell, you can withdraw the money in an IRA and put it in a Coverdell. Depending on your age and the status of your account, you may owe a penalty tax and income tax on the withdrawn amount. Income tax won't be due on contributions to a Roth IRA, but will be due on any earnings if the account hasn't been open for five years. Income tax will be due on any contributions and earnings taken out of a traditional IRA. If you are less than 59 1/2 years old, you will owe 10 percent of the amount taken out on top of any income tax due.
Using an IRA For School
It is possible to use a traditional or Roth IRA for school without moving the money into a Coverdell account. Money from an IRA used to pay for educational expenses for either the account holder, a spouse or a child won't be subject to the 10 percent penalty tax, though income tax will be due on withdrawals from a traditional IRA or earnings from a Roth IRA that is less than five years old. Avoid paying income tax on Roth earnings by only withdrawing the amount you contributed to the account.
Considerations and Other Options
While a Coverdell is designed to be used to pay for education, it may be limiting for some people. The contribution limit is very low and the time frame for contributing is short. A parent may choose to start an IRA for a child's education since the contribution limit per year is higher, $5,000 per year as of 2011, even though the account cannot be converted to a Coverdell. If it's a traditional IRA, there is no income restriction for contributions. Other college saving options include opening a 529 plan, which usually have much higher contribution limits.
- IRS: Coverdell Education Savings Account
- IRS: Publication 970: Education Exception to Additional Tax on Early IRA Distributions
- Bankrate; Uncle Sam Offers a Tax-Free Way to Save on School; Kay Bell; 2008
- Saving for College: Intro to ESAs
- Bankrate; Convert IRA to 529 For College Expenses; Don Taylor; 2011
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