With the recent changes in the federal tax law, education IRAs
have become a more attractive choice to help fund education than
they used to be. Education IRAs are essentially a tax-deferred way
of growing money to help pay for a child’s higher education. The
main attraction to these accounts is that as long as the money is
used for qualifying expenses, which we discuss, the distributions
Under the old tax law, contributions were limited to $500 per year.
Considering the fact that this money was going to be used for college
education, that $500 limit was pretty paltry. However, with the change
in the law, the new limit is $2000 per year, which is more reasonable.
Unlike traditional and Roth IRAs, the person benefiting from the education
IRA doesn’t need to have any earnings. This works especially
well if the education IRA is for a child whose parents have been
phased out from being able to contribute.
There are limitations to the amount of income the donor can earn
and still make contributions. For those who file as single on their
taxes, they can have a maximum adjusted gross income of between
$95,000 and $110,000 until the ability to contribute is completely
phased out. For those filing as married, the maximum adjusted gross
income is now between $190,000 and $220,000 (double the limitations
for single filers) before the contribution is phased out. Therefore,
for families who want to make contributions to education IRAs
but fall outside the AGI limits and are ineligible to make contributions,
it makes sense to encourage the children to make contributions.
Also, any contribution to an education IRA is not counted with
any traditional or Roth IRA contributions. They are considered to be
Contributions to education IRAs are done on an after-tax basis
and cannot be deducted on your federal income tax return. The
money will grow tax-deferred and then all qualified distributions
will be tax-free. In the past, the only distributions that qualified to be
tax-free were any postsecondary tuition costs, fees, books, supplies,
and equipment. In addition to those, this year, the government has
added many other types of qualifying expenses. Now, the definition
includes expenses from elementary or secondary schools, certain
types of room and board costs, uniforms, computers, and extended
day programs costs.
There are some cases where the amount of money that can be distributed
tax-free is reduced by any nontaxable scholarships, fellowship
grants, and educational assistance allowances. The change in the
tax law has now allowed for the coordination of the benefits from the
education IRA and the HOPE and Lifetime Learning credits for education
expenses, so that there is no dual tax benefit for the same
As with traditional IRAs, there is a required distribution age for
any unused portion of the education IRA. Additionally, unused
money may be rolled over into another education IRA for another
family member. A rollover may be made as long as the original
owner of the education IRA is under the age of 30. However, if the
rollover isn’t done and the beneficiary reaches 30 years of age, the
remaining portion of the IRA must be distributed to the beneficiary.
This money will then be taxed at the individual’s ordinary income
rate, including a 10-percent early withdrawal penalty. This, of course,
seems unfair. After all, the government is requiring you to take out
the money that hasn’t been used; yet they are penalizing you because
it is technically a premature distribution. This is why it’s important
either to use the entire amount, or roll over any unused portion.
Because the limit on annual contributions to an education IRA is
$2000, there is no worry about triggering any gift tax to the recipient.
But, when rolling over an unused education IRA, there is potential
for gift tax consequences. If the rollover is made to a family member
of the same generation (i.e., brother to sister, etc.), there is no taxable
gift. However, if the rollover is made from one generation to the next,
the gift tax could apply. As long as the education IRA rollover is
$11,000 or less, there would be no gift tax. Rollovers that exceed
$11,000 would be subject to the tax.