6 Tips to Kickstart Succession Planning with Your Business Owner Clients
Here are 6 tips you can share with your business owner clients to help kickstart their succession planning.
For many parents, paying for college is one of the greatest expenses they might face throughout their child’s lifetime. Choosing to invest in a Coverdell Education savings account, or Coverdell ESA, is one way your clients with children can help ease their worries about college education expenses and help them save for college. Coverdell ESAs are one of the federally sponsored custodial accounts that can be set up on behalf of a designated beneficiary for them to use for qualified education expenses once they turn 18.
Coverdell ESAs are specifically set up for a beneficiary that is under the age of 18 or has special needs, and after the age of 18 contributions cannot be made (unless the beneficiary has special needs). Coverdell ESAs allow your clients to save for college and university expenses and, like 529 plans, tuition for elementary and secondary schools. Coverdell ESAs are not tax deductible and funds must be used by the beneficiary before they turn 30, although beneficiaries could be renamed if your client’s child ages out without using the funds.
To get started with a Coverdell ESA, your client will want to make sure they satisfy a few requirements. First, the beneficiary must be under the age of 18, or be a special needs beneficiary. Second, the account must be designated as a Coverdell ESA at the time of creation. And lastly, the document creating and governing the account must be in writing, and it must meet certain requirements1. For more information on these requirements during set up, a tax professional can help answer questions regarding your clients’ investment in Coverdell ESAs.
ESAs and 529 plans are not mutually exclusive. A child can have both an ESA and a 529 account, and contributions can be made to both accounts in the same year2. Many families find it optimal to contribute the first $2,000 for the year to the ESA, and the rest to a 529 plan. Although contributions may be made to both an ESA and a 529 account in the same year, be aware that there may be gift tax implications if more than $17,000 is contributed per beneficiary in 2023.
An ESA contribution made for another person is a completed gift, but in most cases not a taxable gift because of the annual gift tax exclusion—which is $17,000 in 2023, up from $16,000 in 2022. That means, for example, there is only a taxable gift to the extent the 2023 ESA contribution amount, combined with other completed gifts by the donor to the same ESA beneficiary for 2023, exceeds $17,000. The annual exclusion amount is adjusted annually for inflation.3
If a taxable gift is made, the donor must file a gift tax return but usually there is no immediate tax (because of the unified credit against the gift and estate taxes.)4
In general, your clients can contribute $2,000 each year to a Coverdell ESA. 529 plans, another option for investment, do not have an annual contribution limit, other than the annual gift tax exclusion. Contributions to a Coverdell ESA must be made in cash, and contributions are not deductible.
There are two contribution limits:
Any individual (this could be family members, friends, etc) who meets income requirements can make a non-deductible contribution to a Coverdell ESA on behalf of the beneficiary. The $2,000 limit per year is an aggregate amount, per beneficiary, no matter how many donors contribute.7 Any individual whose modified adjusted gross income is under the limit set for a given tax year can make contributions: in 2022 for single taxpayers with an AGI of $95,000 and below, and joint taxpayers with an AGI of $190,000 or below. Above these AGI levels, the contribution amount is reduced and completely phased out for single taxpayers with an AGI of $110,000 or more and joint taxpayers with an AGI of $220,000 or more8.
It may be possible, however, to contribute more than the annual gift tax exclusion amount, but gift tax issues will vary by state.9 Advising your clients to talk to a tax professional can help with these types of situations.
Coverdell ESA money must be used for qualified education expenses, including tuition and fees, and any other necessary expenses at an educational institution. For example, funds can be used to purchase books, lab fees, student activity fees, transportation, stationery supplies, technology fees, and impairment-related expenses necessary for the beneficiary to attend school or perform schoolwork (e.g. prosthetic devices necessary to operate school machines or other types of equipment)10.
Coverdell ESA distributions can be made at any point in time. If the funds are used for the qualified education expenses of the beneficiary it will usually not be considered taxable income for the beneficiary11. There is also no limit on the number of separate Coverdell ESAs that can be opened for a beneficiary12.
Coverdell ESA contributions are not tax-deductible, however earnings on contributions are distributed tax-free as long as the funds are used for qualified purchases.
Similar to a 529 plan, Coverdell ESA’s can negatively impact the beneficiary’s ability to qualify for need-based aid. Need-based aid for schooling will typically consider the savings and investments a beneficiary has, but this can vary based on their specific circumstances. In general, a post-secondary savings account will make it harder for a beneficiary to qualify for need-based aid, as there is technically less need.
Your client’s beneficiary must utilize their Coverdell ESA funds before the age of 30. If there is a balance left in the Coverdell ESA at the time the beneficiary reaches 30 years old, the funds must be distributed within 30 days. These funds are taxable and subject to a 10% penalty. One way your client’s beneficiary could avoid this tax penalty would be to roll the full balance over to another Coverdell ESA to another family member. Special needs beneficiaries, however, are not generally subject to any age restrictions13.
You can read more on about 529 plans on our blog, and stay tuned for our final blog in the saving for college series when we cover UGMA Accounts.
This content of this article is provided for informational purposes only and should not be construed as investment, tax or legal advice. The information provided is based on current laws, which are subject to change at any time, and has not been endorsed by any government agency.
Nationwide and its representatives do not give legal or tax advice. An attorney or tax advisor should be consulted for answers to specific questions.
[ I.R.C. §530(d)(2)(C)(ii)]
[I.R.C. §§530(d)(3), 529(c)(2)(A)(i), 2503(b), 2503(e) ; Rev. Proc. 2021-45, 2021-48 I.R.B. 764; Rev. Proc. 2020-45, 2020-46 I.R.B. 1016]
[I.R.C. §§2505, 2010(c)]
Individual Retirement Account Answer Book – McNeil and Salkin,Q 14:22
Individual Retirement Account Answer Book – McNeil and Salkin,Q 14:5