Education IRAs

A.  Background

(1) Effective on January 1, 1998

(2) Have nothing to do with IRAs, which are retirement plans whereas education IRAs are solely for education savings

(3) Education IRAs are set up as trust or custodial accounts for a designated beneficiary; education IRAs must be designated as such

(a) Designated beneficiary is any child under 18

(b) Account can be opened at any bank or other institution approved to serve as trustee or custodian

(c) IRS has announced procedures that institutions must follow to get IRS approval to be a trustee or custodian (Notice 97-57, IRB 1997-43, 19; 97RED ¶46,546; CFTS §C:22.61)

B.   Contribution limits

(1) Contributions limited to $500 per year can be made for a designated beneficiary until the beneficiary reaches age 18

(a) $500 limit is an aggregate figure (i.e., contributions can be placed in a single education IRA or in multiple education IRAs)

(b) If more than $500 is contributed per child, it is treated as an excess contribution

(c) If excess contributions are not withdrawn from the child's account by the due date of the tax return, there is a 6% penalty

(d) Contributions must be made only in cash (i.e., property contributions, such as stock, are not allowed)

(e) Contributions can be made by anyone (i.e., relationship to child not required)

(2) Full contribution can only be made if MAGI is no more than $150,000 on a joint return ($95,000 for singles)

(a) Contribution phases out for MAGI between $150,000 and $160,000 on a joint return (between $95,000 and $110,000 for singles)

(b) Example: If single parent has MAGI of $96,500 in 1998, his or her top contribution is $450

C.  Taxation of education IRAs

(1) Earnings on education IRA investments are not subject to tax when earned

(2) When distributions are taken, they are excludable from the income of the beneficiary to the extent they do not exceed qualified education expenses during the year the distributions are made

(a) Qualified higher education expenses include tuition, fees and room and board if beneficiary is enrolled on an at least half-time basis

(i) Room and board is the posted rate by the school, or $2,500 per year for students living off campus but not at home

(ii) Beneficiary need not be enrolled on any special basis to treat tuition as an eligible expense

(3) If a beneficiary takes a distribution for other than to pay qualified education expenses, a portion of the distribution is taxable

(a) Taxable portion is the portion that represents earnings that have accumulated tax free in the account

(b) There is a 10% penalty, unless certain exceptions apply

(i) Distribution from an education IRA can be rolled over tax free to another education IRA for the same beneficiary or for certain other designated beneficiaries (children of the beneficiary, stepchildren, siblings and their children, parents, grandparents, stepparents, and spouses of these people)

(ii) Same 60-day rollover period applicable to regular IRAs applies to education IRAs

(4) Earnings portion of an education IRA not used for qualified higher education expenses by the time the beneficiary reaches age 30 and not rolled over to an eligible designated beneficiary is treated as a deemed distribution

(a) According to Technical Corrections Bill (H.R. 2645) not yet enacted, the distribution is deemed to occur within 30 day of attaining age 30 or within 30 days of death of the beneficiary, whichever comes first

(b) However, if a family has younger children, the unused portion of the education IRA can be rolled over to an education IRA of a younger child

(c) Once the youngest child reaches age 30, there is no more opportunity for deferral; it becomes taxable to the younger child

(5) Contributions cannot be made to an education IRA if contributions are also made to a state tuition program

(a) If such contributions are made, they are treated as an excess contribution subject to the 6% penalty

(6) If tax-free distributions are taken from an education IRA, then no HOPE credit or lifetime learning credit can be claimed that year

Estate Planning 

Tax Incentives for Saving for Higher Education

Qualified State Tution Programs

Tax Incentives for Paying for Higher Education

Lifetime Learning Credit

Penalty-free IRA Withdrawals

 

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