Taxes on Cashing Out a Coverdell Education IRA

by Jane Meggitt

Formerly known as education individual retirement accounts (IRAs), Coverdell Education IRAs can be used to help you save for a child's higher education. As long as the funds are used for educational expenses, there are no taxes due when a Coverdell Education IRA is cashed out. Eligible educational expenses include tuition, books, required equipment, fees, supplies, room and board, computers, transportation and uniforms.

Coverdell Education IRAs

The Coverdell Education IRA is a custodial or trust account for the sole purpose of saving for educational expenses for the account beneficiary. Designation as a Coverdell Education IRA is required at the time of the account's establishment. Accounts may be set up through banks, brokerages and mutual fund companies. Distributions from the account must be made by the time the beneficiary reaches the age of 30, except for special needs students.

Contributions

Although a minor may have several Coverdell Education IRA accounts opened in his name, the total annual contributions for all accounts combined cannot exceed $2,000. While the contributions from the adult contributor are not tax-deductible, like traditional IRAs, the assets in the Coverdell IRA are tax-free until distribution. Contributions are no longer permitted once the beneficiary turns 18. If the original beneficiary is not going to use the funds for higher education, the Internal Revenue Service permits the assets to be rolled over into a Coverdell IRA account of the beneficiary's immediate family.

Taxable Distributions

In some cases, the distributions from the Coverdell Education IRA are taxable to the beneficiary if the amount exceeds the person's educational expenses. If this occurs, the IRS taxes the excess amount to the beneficiary as ordinary income, as well as levying an additional 10 percent penalty on the overage.

A Family Affair

Parents, grandparents, aunts and uncles and others can contribute to a child's Coverdell account rather than purchase other college savings vehicles such as U.S. savings bonds. Depending on the type of account investment, such mutual funds, there may be a minimum individual investment amount. However, the actual accounts must be opened in the name of the beneficiary or the parents of the beneficiary.

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