Withdrawal Penalty
A 10% withdrawal penalty, computed on Form 5329, applies to the TAXABLE PORTION of all distributions, unless the distribution is:
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Made after the death of the designated beneficiary,
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Attributable to the beneficiary’s disability, or
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Made on account of a scholarship or other payment described in §25A(g)(2) [education credits] to the extent the amount of the distribution isn’t more than the amount of §25A(g)(2) payment.
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Excess contributions (over the dollar limit for the year) and the excess is returned, along with income attributable to it on or before June 1 of the tax year following the calendar tax year in which the contribution was made and the net income is included in the account beneficiary’s income in the year of the contribution.
Example - Excess Contributions to Coverdell Accounts and Corrections - Bill and Jana, a married couple with a modified AGI of $225,000, contributed $2,000 to their 16-year-old daughter’s Coverdell account in 2022. In 2023 (before the 2022 return due date), the couple realized that their modified AGI was too high for them to qualify for a 2022 contribution. As a result, the $2,050 in the Coverdell account ($2,000 contribution plus $50 of earnings) was distributed to their daughter. The daughter’s 2022 gross income will include the $50 of earnings on the account. The daughter will also be subject to the 10% distribution penalty on the $50 of earnings.
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| Daughter’s Distribution | $2,050 |
| Basis | <2,000> |
| Taxable Portion | $50 |
| Tax (Presumed to be 10%) | $5 |
| 10% Penalty | $5 |