What is an Education IRA?
An Education IRA is also called a Coverdell ESA account and is used for the education of minors, and established under guidelines that are established by the Federal government. The amount that can be contributed into this account cannot be in excess of $2,000 per year, per beneficiary. A beneficiary is defined as someone who is under the age of 18. One of the special considerations of this Education IRA is that there are income limitations for those that are contributing to the account. Contributions can be made into this account for each tax year until the taxpayer files their annual return.
This type of education account is not as widely used as other more recently added accounts, as the contributions to this account are not tax deductible. The funds once they have been deposited into this account will grow tax deferred until they are withdrawn. If the funds inside of the Education IRA are used for qualified higher education expenses, the beneficiary will not owe any taxes on the withdrawals. Qualified education expenses can include primary and secondary expenses. This tax free benefit is one of the most significant reasons for the use of an Education IRA for education expenses.
When considering investing into any savings vehicle, it is important to understand all of the advantages and disadvantages. Some of the advantages of using an Education IRA are:
- Tax free growth is the largest benefit to the leveraging this savings plan for qualified education expenses. Also, the savings that are placed inside of this account are able to grow tax deferred annually.
- The account owner, typically a family member, will be in control of the plan until the beneficiary reaches the age of majority. The age of majority is currently 30 for the beneficiary.
- Many families are attracted to the Education IRA due to the ability for anyone to contribute to the Education IRA for a specific beneficiary.
- Families can transfer the assets of one Education IRA to another if the funds are unused. For example, if one child does not use the funds, the funds can be moved into another beneficiary’s account.
If the funds are used for anything other than qualified educational expenses, there will be a 10% penalty when the funds are withdrawn. For this reason, it is important to properly plan for the future costs of education and to fully understand the features and benefits of any investment vehicle.
Some other disadvantages include:
- Contributions into an Education IRA may limit the eligibility of the beneficiary to participate in other available investment programs. Some programs that are often also considered for higher education expenses are the Hope Scholarship Credit, prepaid tuition plans and the Lifetime Learning Credit. It is advised to research these options and the effects of contributions into an Education IRA on eligibility for leveraging other options
- The contributions to this plan are limited to $2,000 per child, or beneficiary.
- The contributions into an Education IRA are not tax deductible.