Bob Parrish C PA. P.C.

Education IRAs - Plain English

Telephone — 
FL 941/387-0926
TX 915/367-3465

Fax— 
FL 941/387-0823
TX 915/367-3465

Email: pro1040@home.com On the Web: www.pro1040.com

Consultant & CPA For
Taxpayer Advocate Individuals
Shareholders
Partners
LLC Members
Beneficiaries
Trustees & Estate
Administrators
Sole Proprietors
Mgt. Consulting
Accounting

Simply to Help —Helping You
To Keep More Of What You
Earn and Helping You To
Protect What You Keep

  - Help To Keep Your Life In Balance

Privacy Statement

Privacy Statement

Warning   

CLICK AN IMAGE OR READ ON      

Question or Topic

What is the Education IRA?

The Answer

NOTE: New rules were enacted in 2001 and commence in 2002.  The limit is increased to $2,000 per year and more expenses qualify.  Only post secondary expenses continue to be included.

Summary

An education IRA is a trust or custodial account created or organized in the United States only for the purpose of paying the qualified higher education expenses (defined later) of the designated beneficiary of the account. When the account is established, the designated beneficiary must be a child under age 18. To be treated as an education IRA, the account must be designated as an education IRA when it is created.

Education incentives. Beginning in 1998, a number of tax benefits are available to families who are saving for or paying higher education costs or who are repaying student loans. These benefits are briefly explained here.

1. Education credits. For qualified tuition and related expenses paid after December 31, 1997, for academic periods beginning after that date, you may be able to claim a Hope credit of up to $1,500 for each eligible student. For qualified tuition and related expenses paid after June 30, 1998, for academic periods beginning after that date, you may be able to claim a lifetime learning credit of up to $1,000 for all students. However, you cannot take the Hope credit and the lifetime learning credit for the same student in the same year.
2. Student loans. For payments due and paid after 1997, you may be able to deduct interest you pay on a qualified student loan. And, if a student loan is canceled, you may not have to include the canceled debt in income.
3. Education IRA. You may be able to contribute up to $500 each year to an education IRA for a child under age 18. Contributions to an education IRA are not deductible, but amounts deposited in the account grow tax free until withdrawn. Withdrawals from an education IRA to pay the child's qualified higher education expenses are also tax free.
4. Withdrawals from traditional or Roth IRAs. You can make withdrawals from your traditional or Roth IRA for qualified higher education expenses. (A traditional IRA is an IRA that is not a Roth IRA, SIMPLE IRA, or education IRA.) You will owe income tax on at least part of the withdrawal but you will not have to pay the 10% tax on early withdrawals.

You cannot claim more than one type of tax benefit for the same expense. If you use all or part of your qualifying educational expenses as the basis for any of the new benefits, you must reduce the amount of your qualifying educational expenses when computing your educational expense deduction.

Education IRA

You may be able to contribute up to $500 each year to an education individual retirement account (education IRA or Ed IRA) for a child under age 18. Contributions to an education IRA are not deductible.

Any individual (including the child) can contribute to a child's education IRA if the individual's modified adjusted gross income (defined later) is not more than $110,000 ($160,000 on a joint return). The $500 maximum contribution for each child is gradually reduced if the individual's modified adjusted gross income is between $95,000 and $110,000 (between $150,000 and $160,000 on a joint return). See Who Can Contribute to an Education IRA?, later.

There is no limit on the number of education IRAs that can be established designating the same child as the beneficiary. However, total contributions for the child during any tax year cannot be more than $500.

Amounts deposited in the accounts grow tax free until distributed (withdrawn).

If, for a year, withdrawals from an account are not more than a child's qualified higher education expenses (defined later) at an eligible educational institution (defined later), the child will not owe tax on the withdrawals. See Distributions, later, for more information.

What Is an Education IRA?

An education IRA is not a retirement arrangement. It is a trust or custodial account created only for the purpose of paying the qualified higher education expenses (defined later) of the designated beneficiary of the account. To be treated as an education IRA, the account must be designated as an education IRA when it is created.

Trust requirements. The document creating and governing the trust must be in writing and must satisfy certain requirements. See Publication 590.

Designated beneficiary. The individual named in the document creating and governing the trust or custodial account to receive the benefits of the funds in the account is the designated beneficiary.

Qualified higher education expenses. These are expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution. The term "qualified higher education expenses" means expenses for:

1. Tuition,
2. Fees,
3. Books,
4. Supplies, and
5. Equipment.

The term also includes:

1. Amounts contributed to a qualified state tuition program.
2. Room and board if the designated beneficiary is at least a half-time student at an eligible educational institution. A student is enrolled at least half-time if he or she is enrolled for at least half the full-time academic workload for the course of study the student is pursuing as determined under the standards of the institution where the student is enrolled. Room and board is limited to:
   1. The school's posted room and board charge for students living on-campus, or
   2. $2,500 each year for students living off-campus and not at home.

Eligible educational institution. This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in the student aid programs administered by the Department of Education. It includes virtually any accredited public, nonprofit, or proprietary (privately owned profit-making) postsecondary institution.

Who Can Contribute to an Education IRA?

Any individual (including the designated beneficiary) can contribute to a child's education IRA if the individual's modified adjusted gross income (discussed later) for the tax year is less than $110,000 ($160,000 for married taxpayers filing jointly).

Contributions can be made to one or several education IRAs for the same child provided that the total contributions are not more than the contribution limit (defined later) for a tax year.

Qualified state tuition program. No contributions can be made to an education IRA on behalf of a beneficiary if any amount is contributed during the tax year to a qualified state tuition program on behalf of the same beneficiary.

Contribution Limit

The maximum total contribution for each designated beneficiary (child) is $500 for a tax year. This includes contributions to all the child's education IRAs from all sources other than rollovers. See Can Education IRA Assets Be Moved?, later.

Reduced limit for certain contributors. If your modified adjusted gross income is between $95,000 and $110,000 (between $150,000 and $160,000 for married taxpayers filing jointly), the $500 maximum contribution for each child is gradually reduced. If your modified adjusted gross income is $110,000 or more ($160,000 or more for married taxpayers filing jointly), you cannot contribute to anyone's education IRA. See Publication 590 for more information.

Modified adjusted gross income. Your modified adjusted gross income for the purpose of determining the contribution limit is the adjusted gross income shown on your return, increased by the following exclusions from your income.

1. Foreign earned income of U.S. citizens or residents living abroad.
2. Housing costs of U.S. citizens or residents living abroad.
3. Income from sources within:
   1. Puerto Rico,
   2. Guam,
   3. American Samoa, or
   4. The Northern Mariana Islands.

Additional tax on excess contributions. A 6% excise tax applies to excess contributions made on behalf of a designated beneficiary each year they remain in the account.

The penalty does not apply if the excess contributions (and any earnings on them) are withdrawn before the tax return for the year is due.

Even if the beneficiary of an education IRA is not required to file a return for the year, the contributions (and the earnings on them) must be withdrawn on or before a certain date to avoid the penalty. The due date for these beneficiaries is the 15th day of the 4th month of the year following the year the contributions were made.

Other contribution rules. You can contribute only cash to an education IRA. You cannot contribute to an education IRA after the beneficiary reaches his or her 18th birthday.

Can Education IRA Assets Be Moved?

You can roll over assets from one education IRA to another. You can also change the designated beneficiary or transfer the beneficiary's interest to a spouse or former spouse.

Rollovers

Any amount withdrawn from an education IRA and rolled over to another education IRA for the benefit of the same designated beneficiary or certain members of the designated beneficiary's family is not taxable. This rule applies only if the beneficiary of the new IRA is under age 30 on the date of the rollover contribution to the new IRA.

An amount is rolled over if it is paid to another education IRA within 60 days after the date of the withdrawal.

Members of the beneficiary's family. The beneficiary's spouse and the following individuals and their spouses are members of the beneficiary's family.

1. The beneficiary's child, stepchild or a descendent of either.
2. A brother, sister, half brother, half sister, stepbrother or stepsister of the beneficiary.
3. A son or daughter of the beneficiary's brother, sister, half brother or half sister.
4. The father, mother, stepfather or stepmother of the beneficiary.
5. A brother or sister of the beneficiary's father or mother.
6. The beneficiary's son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law.

Only one rollover per education IRA is allowed during a 12-month period ending on the date of the payment or distribution.

Changing the designated beneficiary. The designated beneficiary can be changed to certain members of the beneficiary's family (listed earlier). There are no tax consequences if, at the time of the change, the new beneficiary is under age 30.

Transfer incident to divorce. The transfer of a designated beneficiary's interest in an education IRA to his or her spouse or former spouse under a divorce or separation instrument is not a taxable transfer. After the transfer, the interest will be treated as an education IRA in which the spouse or former spouse is the designated beneficiary.

Distributions - Withdrawals

The designated beneficiary of an education IRA can take withdrawals at any time. The withdrawals are tax free to the extent the withdrawals do not exceed the designated beneficiary's qualified higher education expenses during the year. See When Must Education IRA Assets Be Distributed?, later.

Are Distributions Taxable?

The tax treatment of distributions (withdrawals) from an education IRA depends, in part, on the qualified higher education expenses that a designated beneficiary has in a tax year.

Distribution not more than expenses. Generally, a withdrawal is tax free if it is not more than the designated beneficiary's qualified higher education expenses in a tax year.

Waiver of tax-free treatment. The student may waive the tax-free treatment of the education IRA distribution and elect to pay any tax that would otherwise be owed on the distribution. The student or the student's parents may then be eligible to claim a Hope credit or lifetime learning credit for qualified higher education expenses paid in that tax year.

Distributions more than expenses. Generally, if the total withdrawals for a tax year are more than the qualified higher education expenses, a portion of the amount withdrawn is taxable to the beneficiary.   For more information, see Publication 590.

The taxable portion is the amount that represents earnings that have accumulated tax free in the account. Figure the taxable portion as shown in the following steps.

1. Multiply the amount withdrawn by a fraction. The numerator is the total contributions in the account and the denominator is the total balance in the account before the withdrawal(s).
2. Subtract the amount figured in (1) from the total amount withdrawn during the year. This is the amount of earnings included in the withdrawal(s).
3. Multiply the amount of earnings figured in (2) by a fraction. The numerator is the qualified higher education expenses paid during the year and the denominator is the total amount withdrawn during the year.
4. Subtract the amount figured in (3) from the amount figured in (2). This is the amount the beneficiary must include in income.

Example. You receive a $6,000 withdrawal from an education IRA to which $10,000 has been contributed. The balance in the IRA before the withdrawal was $12,000. You had $4,500 of qualified higher education expenses for the year. Using the steps above, you figure the taxable portion of your withdrawal as follows.

1. $6,000 × ($10,000 ÷ $12,000) = $5,000
2. $6,000 - $5,000 = $1,000
3. $1,000 × ($4,500 ÷ $6,000) = $750
4. $1,000 - $750 = $250

You must include $250 in income as withdrawn earnings not used for the expenses of higher education.

You cannot take a deduction or credit for any educational expenses that you use as the basis for a tax-free withdrawal from an education IRA. But see Waiver of tax-free treatment, next.

Waiver of tax-free treatment. The student may waive the tax-free treatment of the education IRA withdrawal and elect to pay any tax that would otherwise be owed on the withdrawal. The student or the student's parents may then be eligible to claim a Hope credit or lifetime learning credit for qualified higher education expenses paid in that tax year. (See Education Tax Credits, earlier, to determine if you meet all of the requirements for those credits.)

Additional tax. Generally, if you receive a taxable distribution, you must pay a 10% additional tax on the amount included in income.

Exceptions. There are exceptions to the 10% additional tax for special situations such as the death or disability of the designated beneficiary. For more information, see Publication 590.

Exceptions. The 10% additional tax does not apply to the following withdrawals.

1. Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary.
2. Made because the designated beneficiary is disabled. You are considered to be disabled if you show proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long-continued and indefinite duration.
3. Made because the designated beneficiary received a qualified scholarship excludable from gross income, an educational assistance allowance, or payment for the designated beneficiary's educational expenses that is excludable from gross income under any law of the United States to the extent the withdrawal is not more than the scholarship, allowance, or payment.
4. Included in income only because the student waived the tax-free treatment of the withdrawal (as explained earlier).
5. A return of an excess contribution (and any earnings on it) made before the due date of the beneficiary's tax return (including extensions). If the beneficiary does not have to file a return, the excess (and any earnings) must be withdrawn by April 15 of the year following the year of the contribution. Any income earned on the excess contribution also must be included in the beneficiary's gross income for the tax year the contribution was made.

When Must Education IRA Assets Be Distributed?

Generally, any assets remaining in an education IRA must be withdrawn when either one of the following two events occurs.

1. The designated beneficiary reaches age 30. In this case, the designated beneficiary must withdraw the remaining assets within 30 days after he or she reaches age 30.
2. The designated beneficiary dies before reaching age 30. In this case, the remaining assets must generally be withdrawn within 30 days after the date of death.

The withdrawn earnings that accumulated tax free in the account, generally, must be included in taxable income.

The earnings that accumulated tax free in the account must be included in taxable income. You determine these earnings as shown in the following two steps.

1. Multiply the amount withdrawn by a fraction. The numerator is the total contributions in the account and the denominator is the total balance in the account before the withdrawal(s).
2. Subtract the amount figured in (1) from the total amount withdrawn during the year. The result is the amount of earnings included in the withdrawal. The beneficiary must include this amount in income.

Exception for transfer to surviving spouse or family member. If an education IRA is transferred to a surviving spouse or other family member (defined earlier) under age 30 as a result of the death of the designated beneficiary, the education IRA retains its status. This means that the spouse or other family member is treated as the designated beneficiary of the education IRA. There are no income tax consequences as a result of the transfer.

Withdrawals From Traditional or Roth IRAs

You can make withdrawals from your traditional or Roth IRA for qualified higher education expenses. A traditional IRA is an IRA that is not a Roth IRA, SIMPLE IRA, or education IRA. You will owe income tax on at least part of the amount withdrawn but you will not have to pay the 10% additional tax on early withdrawals. (Generally, if you make withdrawals from your traditional or Roth IRA before you reach age 59 1/2, you must pay a 10% additional tax on the early withdrawal.)

Withdrawals for higher education expenses. Part (or all) of any withdrawal may not be subject to the 10% additional tax on early withdrawals. The part not subject to the tax is generally the amount that is not more than the qualified higher education expenses (defined later) for higher education furnished at an eligible educational institution (defined earlier under Rules That Apply to Both Credits for the education credits). The education must be for you, your spouse, or the children or grandchildren of you or your spouse.

When determining the amount of the withdrawal that is not subject to the 10% additional tax, include qualified higher education expenses paid with any of the following funds.

1. An individual's earnings.
2. A loan.
3. A gift.
4. An inheritance given to either the student or the individual making the withdrawal.
5. Personal savings (including savings from a qualified state tuition program).

Do not include expenses paid with any of the following funds.

1. Tax-free withdrawals from an education IRA.
2. Tax-free scholarships, such as a Pell grant.
3. Tax-free employer-provided educational assistance.
4. Any tax-free payment (other than a gift, bequest, or devise) due to enrollment at an eligible educational institution.

Qualified higher education expenses. Qualified higher education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution. In addition, if the individual is at least a half-time student, room and board are qualified higher education expenses.

Solutions are dependent upon facts & circumstances, law and the objectives.  These elements vary from one time to another, from one circumstance to another and from from person or entity to another

 Engagement Status Letter ~ WARNING!

WARNINGS ABOUT THIS SITE'S CONTENT

THE FOLLOWING APPLIES TO ALL PAGES, TEXT, IMAGES AND CONTENT OF THIS SITE   This entire site is for educational or informational purposes only.   You are not to use the forms, concepts, strategies, or knowledge without assistance from a professional.   The author, the corporation, the ISP, Bob Parrish CPA, Bob Parrish CPA, P.C. or other parties related to those or this site do not guarantee or warrantee in any manner the suitability, usefulness, accuracy, timeliness, or results of any portions of this site, nor the links contained in this site which link to other areas.   At times, information is taken from other sources and is believe to be accurate, but no verification or confirmation is performed.  Furthermore, if any federal or state law invalidates a portion of this disclaimer, the other portions still apply.   In addition, any allegations or actions are restricted to arbitration only and must be arbitrated by the Better Business Bureau in Sarasota Florida.  Reading of these pages constitutes complete acceptance and agreement with all disclaimer provisions on all pages of this site. Material provided herein is based upon the most recently available information and is subject to change. It is not intended to be complete and should not be used to make any type of decisions. All should consult a qualified tax adviser and other professional(s) for more complete information.   You have not engaged Bob Parrish CPA PC, Bob Parrish CPA, pro1040, Consulting on line, any related parties, or the ISP to perform any services for you or offer you advice.  This entire site is for educational or informational purposes only.   The materials are not opinions, advise, legal advice on any matter and have not been tailored to specific jurisdictions, individuals, other entities, or circumstances.  You are not to use the forms, concepts, strategies, or knowledge without assistance from a professional.   You must update and validate this information yourself with your own research, experience and the advice of a competent professional adviser in your jurisdiction.  The author, the corporation, the ISP, Bob Parrish CPA, Bob Parrish CPA, P.C. or other parties related to those or this site do not guarantee or warrantee in any manner the suitability, usefulness, accuracy, timeliness, or results of any portions of this site, nor the links contained in this site which link to other areas.   At times, information is taken from other sources and is believed to be accurate, but no verification or confirmation is performed.  Furthermore, if any federal or state law invalidates a portion of this disclaimer, the other portions still apply.   In addition, any allegations or actions are restricted to arbitration only and must be arbitrated by the Better Business Bureau in Sarasota Florida.  The cost of arbitration to the complainant is restricted to the cost through a court having jurisdiction in the matter including if allowed by law the cost of legal fees.  Reading of these pages constitutes complete acceptance and agreement with all disclaimer provisions on all pages of this site. ....... Sunday, March 04, 2007 08:44 AM    All funds, bonds, partnerships, variable insurance products and other securities are not FDIC insured, not bank insured, and not guaranteed by any party, and are offered by prospectus only. You should consult your financial advisor for a prospectus before investing. Please read the prospectus, which contains more complete information on risk considerations, management fees, sales charges, and other expenses, carefully before you invest.  The value of the investment does change and the value will be more or less than your investment.  Historical performance is not indicative of futures results and future results cannot be predicted or guaranteed. Bob Parrish CPA:  License Jurisdictions — CPA: FL, TX   Privacy Statement

Email to pro1040@home.com

Privacy Statement

Or If you want to use your own email editor click here