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March 20, 2000 -- This
tax tip focuses on the facts surrounding Education Individual
Retirement Accounts, which were created Jan. 1, 1998. Because
they haven't been around long, many taxpayers are unaware
of these IRAs or misunderstand their details.
The
basics of putting it away
Parents can deposit up to $500 per year into an Education
IRA for a child younger than 18. Grandparents, other family
members, friends and the children themselves also may contribute
to children's Education IRAs. Just make sure that whatever
contributions are made on behalf of a child during one tax
year don't exceed the $500 limit.
This also means that the limit applies
to contributions made during the tax year, not before taxes
are due. Some parents may have $200 in Junior's Education
IRA, thinking they have until April 15, 2000, to squeeze the
other $300. But the $500 limit applies to contributions for
the tax year. In other words, that $300 will limit contributions
to $200 for the year 2000 instead of 1999.
Another point of confusion for some people
is that adjusted gross income will limit a person's eligibility
to contribute to this IRA. In some cases, that means a parent
cannot contribute to his son's Education IRA, but Grandma,
Uncle Joe or that third cousin from Spokane can.
The income-related limit works on a sliding
scale -- the more you make, the less you can chip in.
Individuals with modified adjusted gross
incomes between $95,000 and $110,000 (between $150,000 and
$160,000 for married taxpayers filing jointly) can contribute
a limited amount to an Education IRA. For example, an unmarried
taxpayer with modified adjusted gross income of $96,500 in
a taxable year could make a maximum contribution per child
of $450 for that year. Once an adjusted gross income exceeds
$110,000 ($160,000 for married taxpayers filing jointly),
the IRS prohibits contributions to anyone's Education IRA.
Withdrawals
Contributions to an Education IRA aren't tax-deductible. However,
they grow tax-free until the child withdraws them. Students
who follow the rules won't have to pay taxes then, either.
The IRS doesn't tax withdrawals from the
account if the child's education expenses at an eligible educational
institution for the year equal or exceed the amount of the
withdrawal. It doesn't matter whether the child enrolls full
time, half time, or less than half time -- if the costs exceed
the withdrawal, they're tax-free.
If the child makes a withdrawal without
having any qualified higher education expenses during the
taxable year, the picture changes. The IRS is going to tax
part of that distribution, specifically the portion that represents
earnings that have accumulated tax-free in the account. The
IRS may also impose a 10 percent additional tax.
But
I don't want to go to college
What happens if Junior turns 18 and decides to see the world
instead of becoming a dentist? Or if he doesn't use all of
the money in the account by the time he finishes college?
If unused money remains in an Education IRA, you have two
options:
- You can roll over the account to other
family members who need it for qualified higher education
expenses. The amount rolled over will not be taxable.
- You can let the designated beneficiary
withdraw the money in the account. Again, keep in mind that
he will be subject to both income tax and the additional
10 percent tax. So weigh your options carefully here.
- For more details on the Education
IRA, see IRS
Notice 97-60.
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