Education IRAs
We would like to advise you of a new tax break for people looking for the best way to save for future education expenses. As part of the 1997 tax legislation, a
new type of account was created called the "education individual retirement account." The tax break from this new education IRA comes in the fact that, although
there is no upfront deduction, distributions from the accounts are not subject to federal income tax to the extent that the amounts distributed are used to pay
qualified higher education expenses (such as tuition, fees, books and room and board) of the education IRA beneficiary.
Distributions from an education IRA are deemed to consist of distributions of principal (which, under all circumstances, are excludable from gross income) and
earnings (which may be excludable from gross income under the education IRA rules). If the qualified higher education expenses of the beneficiary for the year are
at least equal to the total amount of the distribution (i.e., principal and earnings combined) from an education IRA, then the earnings in their entirety are excludable
from gross income.
If, on the other hand, the qualified higher education expenses of the beneficiary for the year are less than the total amount of the distribution, then the qualified higher
education expenses are deemed to be paid from a pro-rata share of both the principal and earnings components of the distribution. Thus, in such a case, the
principal portion of the distribution is entirely excludable. Further, a portion of the earnings is excludable (i.e., a portion of the earnings based on the ratio that the
qualified higher education expenses bear to the total amount of the distribution) and only the remaining portion of the earnings is includible in the gross income of the
distributee.
Contributions to an education investment account may be made only in cash and may not be made after the beneficiary reaches age 18, and annual contributions are
limited to $500 per beneficiary. Any balance in an education IRA must be distributed when the beneficiary turns 30 or dies.
Please note that if a tax-free withdrawal from an education IRA is made for a student in any year, certain tax credits which may otherwise be available for higher
education expenses — the HOPE or Lifetime Learning credits — cannot be claimed for that student for the year.
An additional 10% penalty is imposed on the taxable portion of a distribution from an education IRA that is not made on account of the death, disability, or
scholarship received by the beneficiary. (However, if a taxpayer seeks to qualify for the HOPE or Lifetime Learning Credit and therefore elects to have an
otherwise qualifying distribution from an education IRA be taxable, the 10% penalty will not apply.)
Tax-free transfers or rollovers of account balances from one education IRA benefiting one beneficiary to another account benefiting another beneficiary (as well as
redesignations of the named beneficiary) are allowed, provided that the new beneficiary hasn't reached 30, and is a member of the family of the old beneficiary.
Contributions to education IRAs are considered taxable gifts for gift tax purposes, but are eligible for the $10,000 per donee gift tax exclusion. For estate tax
purposes, amounts distributed from an education IRA will be included in the estate of the designated beneficiary (unless the beneficiary's interest in the education
IRA is rolled over to a beneficiary of the same generation). The interest is not includible in the estate of the contributor.
If you have any questions or wish to discuss the above rules further, please feel free to contact our offices. Of course, we would also be happy to discuss the whole
range of planning options to fund your college tuition needs.
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