Education IRAs
(Regulations as of December 31, 2000)

Note: These excerpted regulations pertain the Education IRAs as of December 31, 2000. Various changes were made during 2001, including renaming Education IRAs Coverdell Educational Savings Accounts. See Coverdell Educational Savings Plans - Changes During 2001.

What Is an Education IRA?

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.

Designated Beneficiary

The individual named in the document creating the trust or custodial account to receive the benefit 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. They include only the following items.

1. Tuition and fees.
2. The cost of books, supplies, and equipment.
3. Amounts contributed to a qualified state tuition program.
4. In some situations, the cost of room and board.

The cost of room and board is a qualified higher education expense if the designated beneficiary is at least a half-time student at an eligible educational institution.

The expense for room and board is limited to one of the following two amounts.

1. The school's posted room and board charge for students living on campus.
2. $2,500 each year for students living off campus and not at home.

Half-time student. A student is enrolled "at least half-time" if he or she is enrolled for at least half the full-time academic work load for the course of study the student is pursuing as determined under the standards of the school where the student is enrolled.

Eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

Contributions

Any individual (including the child for whose benefit the account is established) can contribute to an education IRA if the individual's modified adjusted gross income (defined below) for the year is less than $110,000 ($160,000 in the case of a joint return). Contributions must be in cash, and cannot be made after the beneficiary reaches age 18.

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

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 year.

Contribution Limits

There are two yearly limits, one on the total amount that can be contributed for each designated beneficiary (child) in any year and one on the amount that any individual can contribute for any one child for a year.

Limit for each child. The total of all contributions to all education IRAs set up for the benefit of any one designated beneficiary (child) cannot be more than $500 in a year. This includes contributions (other than rollovers) to all the child's education IRAs from all sources. Rollovers are discussed under Rollovers and Other Transfers, later.

Limit for each contributor. You can contribute up to $500 for each child for any year. This is the most you can contribute for the benefit of any one child for any year, regardless of the number of education IRAs set up for the child. However, this limit may be reduced as explained next.

If your modified adjusted gross income (defined earlier) is between $95,000 and $110,000 (between $150,000 and $160,000 if filing a joint return), the $500 limit for each child is gradually reduced. (See Figuring the limit, next.) If your modified adjusted gross income is $110,000 or more ($160,000 or more if filing a joint return), you cannot contribute to anyone's education IRA.

Rollovers and Other Transfers

Assets can be rolled over from one education IRA to another. The designated beneficiary can be changed and the beneficiary's interest can be transferred to a spouse or former spouse because of divorce.

Rollovers

Any amount withdrawn from an education IRA and rolled over to another education IRA for the benefit of the same beneficiary or a member of the beneficiary's family who is under age 30 is not taxable. 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.

• The beneficiary's child, grandchild, or stepchild.
• A brother, sister, half brother, half sister, stepbrother, or stepsister of the beneficiary.
• The father, mother, grandfather, grandmother, stepfather, or stepmother of the beneficiary.
• A brother or sister of the beneficiary's father or mother.
• A son or daughter of the beneficiary's brother or sister.
• 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 the 12-month period ending on the date of the payment or withdrawal.

Changing the Designated Beneficiary

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

Transfer Because of Divorce

If a spouse or former spouse receives an education IRA under a divorce or separation instrument, it is not a taxable transfer. After the transfer, the spouse or former spouse treats the education IRA as his or her own.  

Withdrawals

The designated beneficiary of an education IRA can take withdrawals at any time. Whether the withdrawals are tax free depends, in part, on whether the withdrawals are more than the amount of qualified higher education expenses (defined earlier) that the beneficiary has in the tax year.

Withdrawals Not More Than Expenses

Generally, withdrawals are tax free if they are not more than the beneficiary's qualified higher education expenses for the tax year.

Withdrawals More Than Expenses

Generally, a portion of the withdrawals is taxable to the beneficiary if the withdrawals are more than the beneficiary's qualified higher education expenses for the tax year.

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

Withdrawal and Deduction or Credit

You generally 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 designated beneficiary can waive the tax-free treatment of the withdrawal and elect to pay any tax that would otherwise be owed on the withdrawal. The beneficiary or the beneficiary'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.

Additional Tax

Generally, if the beneficiary receives a taxable withdrawal, he or she also must pay a 10% additional tax on the amount included in income.

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

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. A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration.
3. Made because the designated beneficiary received:
   1. A qualified scholarship excludable from gross income,
   2. An educational assistance allowance, or
   3. Payment for the designated beneficiary's educational expenses that is excludable from gross income under any law of the United States.

   The exception applies only to the extent the withdrawal is not more than the scholarship, allowance, or payment.

4. Included in income only because the beneficiary 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. The beneficiary must include in gross income for the year the contribution is made any income earned on the excess contribution.

When Assets Must Be Withdrawn

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 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 person receiving the assets 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 as the result of the death of the designated beneficiary, the education IRA retains its status. (For this purpose, family member was defined earlier under Rollovers.) This means the spouse or other family member can treat the education IRA as his or her own. There are no tax consequences as a result of the transfer.

Related Information:
        College Savings - Section 529 Plans Overview
        Coverdell Educational Savings Plans - Changes During 2001
        Ideas and Information About Taxes
        Personal Financial Planning
        Selecting a Tax Advisor
        Tax Services
        Taxes and College Financial Aid

© Copyright 2001 Raymond S. Kulzick. All rights reserved. 010901.