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The Education IRA The Education IRA (EIRA) is in a category all its own. While you may have a traditional IRA as well as a Roth IRA, you may only invest a given maximum annual amount to both of them combined. (See All About IRAs for details on yearly allowable contributions.) The amount that you may contribute annually to an EIRA is in addition to the amount you may contribute to a traditional and/or Roth IRA. In 2001, you may contribute a maximum of $500 annually to an EIRA. For 2002 and beyond, this limit will increase to $2,000 per year. Example: Mom and Dad want to establish an EIRA for little Sissy. Mom wants to donate $500, Dad wants to donate $500, and even Grandpa wants to donate $500. In 2001, they can't do it. Little Sissy (as the beneficiary) is limited to only one $500 contribution into her EIRA account per year, regardless of the source of the funds. But in 2002, the limit rises to $2,000. In that year, Dad, Mom, and Gramps may each contribute $500 because those combined contributions will be within the allowable maximum of $2,000 that becomes effective in 2002. The procedure for calculating the maximum allowable EIRA contribution when the donor's AGI is within the above ranges may be found in IRS Publication 970, "Tax Benefits for Higher Education." Example: Grandpa, a single person, wants to establish an EIRA for little Johnny. But Grandpa's AGI is $100,000. His maximum contribution to little Johnny's EIRA account would be only $333 because of the phase-out rules. Any individual may make the allowable maximum annual contribution to an EIRA for the benefit of any person under age 18. But the maximum contribution limit is phased out ratably for contributors when their modified adjusted gross incomes (AGI) are within certain ranges as shown in the following table: Modified AGI Phase-Out Ranges
for EIRA Contributions*
Year Joint Filers All Other Filers
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2001 $150,000 - $160,000 $95,000 - $110,000
2002** $190,000 - $220,000 $95,000 - $110,000
* For most taxpayers, modified adjusted gross income will be their adjusted gross income (AGI) as figured on their federal income tax return. However, you must modify your AGI if you excluded income earned abroad or from certain U.S. territories or possessions. See IRS Publication 970 for details. ** 2002 and beyond Note that, unlike other IRAs, a person may make a contribution to an EIRA even if that person has no earned compensation for that tax year. This being the case, there is no reason that Grandpa can't give a gift to little Johnny in any amount up to the maximum allowable EIRA contribution limit. Johnny can then turn around and open his OWN EIRA by using that gift as his contribution because Johnny is well under the AGI limits for doing so. Distributions from an EIRA are tax-free if the beneficiary's qualified education expenses for the year equal or exceed the EIRA distribution for that year. In 2001, qualified education expenses are limited to those incurred for tuition, fees, books, supplies, and equipment required for the beneficiary's enrollment or attendance at an "eligible educational institution" (generally considered as an accredited post-secondary educational institution offering credit toward a bachelor's degree, an associate's degree, a graduate-level or professional degree, or another recognized post-secondary credential). While there is no requirement that the beneficiary be enrolled on a half-time or greater basis, if the beneficiary is enrolled on a half-time or greater basis, some of the room and board expenses may also be considered a qualified education expense. For the years 2002 and later, the list of qualified education expenses for EIRA purposes has been expanded to include "qualified elementary and secondary school expenses," meaning expenses for:
Tuition, fees, academic tutoring, special need services, books, supplies, and other equipment incurred in connection with the enrollment or attendance of the beneficiary at a public, private, or religious school providing elementary or secondary education (kindergarten through grade 12) as determined under state law, Room and board, uniforms, transportation, and supplementary items or services (including extended day programs) required or provided by such a school in connection with such enrollment or attendance of the beneficiary, and the purchase of any computer technology or equipment, to include Internet access and related services, if such technology, equipment, or services are to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in school. Computer software primarily involving sports, games, or hobbies is not considered a qualified elementary and secondary school expense unless the software is educational in nature.
As noted earlier, withdrawals from an EIRA to pay for education expenses that meet the above criteria may be taken free of income taxes and penalty.
Example: Dad makes the maximum allowable contribution to an EIRA for his 8-year-old son David for 10 years beginning in 1998. In 2008, when the account balance is $20,500 (including $6,500 in earnings), David withdraws the entire $20,500 balance to pay part of his $25,000 qualified higher education expenses for his first year at Harvard. David's 2008 taxable income does not include the $6,500 in earnings from the EIRA account. (Note: If a beneficiary excludes any amount of an EIRA distribution from his income in a given tax-year, neither a HOPE nor a Lifetime Learning Credit may be claimed for that beneficiary for that year.) If distributions from an EIRA exceed qualified education expenses, there is an additional tax of 10% of the taxable amount. But this 10% additional tax does not apply to distributions:
Example: Using the Dad and David example above, let's say that David decides to take his $20,500 EIRA distribution and go to Europe in 2008. David doesn't incur any qualified education expenses for 2008. In this case, David would have to report income of $6,500 (the earnings on the EIRA). He would have to pay ordinary income taxes on that sum, and he would also have to pay an additional tax of $650 (10% of the taxable amount) as a penalty for not using that money for qualified education expenses. The beneficiary must use the EIRA funds within 30 days after the beneficiary turns 30. Any funds remaining after that time will be deemed distributed to the beneficiary (whether actually distributed or not), and the earnings will be subject to regular income tax and the additional 10% tax if not used for qualified education purposes. But you should know that an EIRA distribution not used for qualified education expenses is not taxable to the extent that it is rolled over into another EIRA for the benefit of the beneficiary, or for the benefit of another member of the beneficiary's family. For this purpose, a family member includes: a son, daughter, or a descendant of either; a stepson or stepdaughter; a brother, sister, stepbrother, or stepsister; a father, mother or an ancestor of either; a stepfather or stepmother; a nephew or niece; an uncle or aunt; and a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. It would also include the spouse of any of those persons. But, the new beneficiary of this rollover distribution must be under age 30 on the date of the rollover. Example: Sam has not used all of his EIRA and will soon turn 30 years old. His account has a balance of $25,000, including earnings of $14,000. Sam doesn't want to take the EIRA as a distribution and pay the normal income tax and additional 10% tax on the $14,000 in earnings. Instead, Sam decides to roll over this $25,000 EIRA to his nephew Jim, who is only 4 years old. Jim now has a BIG head start on his college savings. As with most tax issues, there are other technical requirements regarding the EIRA that space does not allow us to deal with here and now. Therefore, make sure that you do your research. A great way to do that is to read IRS Publication 970, "Tax Benefits for Higher Education." Free IRA Information & Quote
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