A Primer on Education IRAs

Reading, ’riting and ’rithmetic—they’re the basic building blocks of every education. And while most of our children readily master these skills, how we pay for the fabled three “Rs,” especially in the world of post-secondary education, can be anything but academic.

One possible course of action to consider when it comes to funding Junior’s college years is the establishment of an Education Individual Retirement Account (EIRA). Introduced by Congress in 1998, the EIRA is a trust or custodial account created solely for the purpose of paying the qualified higher-education expenses of the designated beneficiary—or future student.

Currently, subject to certain income limits, moms, dads, grandparents, godparents, uncles, aunts, even the children themselves can make a $500 contribution annually to EIRAs for an unlimited number of beneficiaries under the age of 18.

The beauty of EIRAs is that the gains accumulate tax-free, and can be withdrawn tax-free, as long as distributions are for college expenses at an eligible educational institution. Eligible or qualified college expenses include tuition, books, room and board, fees and supplies.

Some things to keep in mind:

• Contributions to EIRAs are not tax-deductible.
• The IRA must be designated as an EIRA when it is created.
• The $500 limit is not per taxpayer. One taxpayer could set up EIRAs for any number of qualifying individuals. However, limitations and restrictions do apply: even if more than one person contributes to a child’s EIRA, the total annual contribution for the child may not exceed $500. No contributions can be made to the EIRA in the same year a contribution is made to a qualified state tuition program for the beneficiary.
• Withdrawals are tax-free and may be made at any time, as long as the money is used for higher education expenses by the beneficiary’s 30th birthday.
• If the individual decides not to go to college or does not use the total balance of the IRA, the account can be liquidated, but will be subject to both income tax and an additional 10 percent tax on the portion of the amount withdrawn that represents earnings. Or, any unused funds can be rolled over to another EIRA for a member of the designated beneficiary’s family. In this instance, the amount rolled over is not taxable.
• Taking tax-free withdrawals from an EIRA disqualifies one from being able to claim the Hope Scholarship Credit or Lifetime Learning Credit for that year.
• Eligibility is not affected by any amounts contributed to traditional or Roth IRAs.

Whether you decide an Education IRA is the way to help fund college for the children in your life, or you select another option, the smart money is on doing whatever you choose to do soon. Doing your homework and educating yourself about EIRAs and other savings options can send both you and Junior straight to the head of the class.