Excess Removal of ESA Contributions Deadline is May 31

For parents and guardians of children under the age of 18, a Coverdell Education Savings Account (ESA) provides a tax-advantaged way to invest in their child’s future. From saving up for university to K-12 expenses along the way, this custodial account is designed to help save and pay for qualifying education expenses. So what happens if your IRA contributions exceed the amount allowed for one year? Let’s take a look at how you can correct excess contributions to your ESA investment account and any penalties if the May 31 deadline is missed. 

What is Meant by ESA Excess Removal?

An ESA limits contributions to $2,000 annually. That includes contributions made directly by a parent or guardian and any family members who decide to contribute to the ESA. Regardless of how many ESA accounts are opened for the student, the sum of the accounts cannot exceed $2,000. If these exceed the limits, the excess must be removed before the deadline.

Furthermore, contributors must meet income requirements that fall within a specific range based on their modified adjustment gross income. For joint applicant tax filers, contributions can only be made if their modified adjusted gross income falls below $190,000, or $95,000 for single filers to qualify for a full $2,000 contribution. If the contributor’s modified adjusted gross income falls between $190,000 and $220,000, or $95,000 and $110,000 for single filers, the $2,000 maximum is gradually phased out.

How do I File my ESA Taxes?

Custodians will fill out an IRS Form 5498 ESA, which is used to report specific information about Coverdell Education Savings Accounts (ESA) to the IRS. The custodian or trustee who oversees the account must file the form. Two copies of the form must be distributed– one copy must be sent to the IRS and the duplicate must be distributed to the beneficiary.

On the form, the custodian must include information regarding the total amount of contributions made to the account throughout the tax year. Additionally, the trustee must report any account transfers or rollovers on their Form 5498 ESA. 

What Happens if I Miss the Excess Removal Deadline?

Consequences for failure to remove excess Coverdell ESA contributions will depend on the steps taken to correct excess contributions in a timely manner. If no action is taken to correct the allocated excess contributions, the IRS will charge the designated beneficiary a 6% penalty tax on the excess amount.

This penalty is charged at 6% per year for each year the excess amounts remain in the ESA . Custodians must manage the excess contribution removal of the ESA before the first day of the sixth month following the taxable year.

What are Some Alternative Solutions?

Funds from an ESA can be rolled over into a 529 account. Transfer withdrawals from an ESA are tax-free if they are made in the same taxable year as contributions to a 529 account for the same beneficiary. If the 529 plan is funded within 60 days, the distribution is tax-free.

A trustee-to-trustee transfer from a Coverdell ESA to a 529 plan is also possible. State income tax benefits are not available for Coverdell ESA contributions, although rollover contributions from a Coverdell ESA to a 529 plan may be eligible for tax benefits in some states. 

How can IRAR Help?

More and more options are becoming available to plan for the financial future of your child’s education. Navigating the variety of investment options available can be exciting, yet challenging– especially if you’re trying to figure it out on your own. 

IRAR has over 30 years of experience providing folks with the resources needed to boost their financial literacy when it comes to alternative and retirement investment accounts. Book a free consultation with one of our experts today to see if you're on track to meet the ESA excess removal deadline or any other inquiries you may have about the filing process.