View Full Version : Coverdell ESA question
09-14-2009, 10:01 AM
Let's say that my daughter turns out to be a super genius and gets a 100% full paid scholarship to a college. What happens to the money I've put in her ESA? Does she have to pay penalties? Taxes? On the whole amount, or just the earnings?
09-14-2009, 01:08 PM
Earnings that are not spent on educational expenses by her 30th birthday will be subject to income taxes and a 10% penalty. Before her 30th birthday it would be possible to transfer the money tax/penalty-free into a Coverdell ESA for a qualifying relative like a sibling, cousin, niece/nephew, spouse or child.
09-14-2009, 01:23 PM
Some of the benefits that students receive in a "free ride" scholarship are actually taxable. For example, any work-study income and any scholarship money used for room & board. You can still take out tax-free Coverdell distributions up to the amount of taxable benefits received.
Example: Student receives $20,000 scholarship for tuition, $10,000 scholarship for room & board, and $5,000 in work-study income. The last two items are both taxable income. The student can take $15,000 in Coverdell distributions tax free (less any amount used to take an education credit).
It is often a good strategy to put education accounts in the name of the grandparents with grandchildren as beneficiaries. They can shift the funds to any grandchild if the first beneficiary doesn't need it.
09-15-2009, 04:14 AM
Thanks for the answers. She is an only child, so there would be nobody else to transfer the money to. I could understand having to pay taxes if they are not used for education, but the law seems to punish the student (with the 10% penalty) for having the audacity to be successful enough to get a full scholarship (the amount in excess of what dracoi describes).
Just to clarify, though. Let's say that she is in the 15% tax bracket. She would owe $1500 on that $10k room and board scholarship, but she could take the full $10k out of the Coverdell account? $1.5k to pay her taxes on the scholarship, and $8.5k of tax-free money? Or am I missing something?
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