Education IRAs
Beginning in 1998, you may be able to make nondeductible contributions
of up to $500 annually to an education IRA for a child under age 18. Earnings
in the IRA accumulate free of income tax. Withdrawals from the IRA are
tax free up to the amount of the child's qualified higher education expenses
for the year. Chapter 3 of Publication
590 has detailed information on education IRAs.
Although created by 1997 legislation, 1998 was the first year that
education IRAs could be established. The following changes are the result
of technical corrections legislation in 1998.
No double benefit allowed. Qualified
higher education expenses used as the basis for tax-free withdrawals from
an education IRA cannot also be used in figuring any deduction or credit
(such as the Hope credit or lifetime learning credit). They also cannot
be used in figuring an exclusion for U.S. savings bond interest used to
pay the expenses. For more information, see Publication
970, Tax Benefits for Higher Education.
Election to include education IRA withdrawal
in income. You can elect to waive the tax-free treatment of
a withdrawal from an education IRA and include it in your income. If you
do, the 10% additional tax will not apply to the withdrawal and you may
be able to claim a credit or deduction for your expenses.
When assets must be withdrawn. The document
creating and governing an education IRA must provide that the balance in
the account must be distributed within 30 days after the beneficiary reaches
age 30 or dies, whichever happens first. If there is no actual distribution
within 30 days, the balance in the account is deemed distributed as of
the close of the 30-day period. If the distribution is the result of the
beneficiary reaching age 30, the distribution is made to the beneficiary.
If the distribution is required because of the beneficiary's death, the
remaining assets must generally be distributed within the 30-day period.
Exception for transfer to 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 spouse
or other family member can treat the education IRA as his or her own.
Rollovers and beneficiary changes. If
a distribution from an education IRA is, within 60 days, contributed to
another education IRA for the benefit of the same beneficiary or a member
of his or her family, it is not a taxable distribution. This rule does
not apply if the beneficiary of the new IRA is age 30 or older on the date
of the rollover contribution to the new IRA.
Similarly, if the designated beneficiary of an education IRA is changed,
it is not a taxable distribution if the new beneficiary is under age 30
on the date of the change.
Excess contributions. The rules for
determining when the 6% excise tax applies to excess contributions has
been expanded. Before the change, the 6% tax applied only to contributions
over $500. Now, if the maximum contribution allowed is less than $500 (because
the contributor's income is above certain levels), the 6% tax applies to
contributions that are more than that lower contribution limit.
Excess contributions for the current year now include excess contributions
from the preceding year that have not been withdrawn (returned) or used
to offset any unused contribution limit for the current year. These contributions
are subject to the 6% tax, along with any excess amounts contributed during
the current year.
Exception. The 6% tax does not
apply if the excess contributions (and any earnings on them) are withdrawn
before the due date of the beneficiary's tax return (including extensions).
If the beneficiary is not required to file a return for the year, the excess
contributions (and the earnings) must be withdrawn by April 15 of the year
following the year the contributions were made.
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