Did you know that an IRA can be used for something more than just retirement? That’s right – it sure can! There is a retirement account that is known as an educational IRA, which is better known now as an ESA – Educational Savings Account. An ESA allows for you to set aside money that can be used in the future for education expenses for your children. An ESA works very similar to a Roth IRA, so if you are familiar with the process of that type of retirement account then you will have a pretty good understanding of an educational IRA.
One of the best things about an educational IRA is that funds can be withdrawn at any time for your children’s expenses for their education and when you withdraw these funds, it is completely tax-free and free from any penalty. However, there is a penalty if you withdraw from the ESA early. Tax deductions cannot be taken from an educational IRA by you nor is the child the account for permitted to do so. This of course is based off the fact that the money is being used for educational expenses.
Now there are some restrictions when it comes to an educational IRA including income restrictions. Your modified adjusted gross income cannot exceed certain predetermined limits. In addition, in order to open an ESA, your child may not have received any type of contribution within that same year for a prepaid state tuition program.
The educational IRA cannot accept funding for the beneficiary after they reach the age of 18 per tax law; therefore, you can fund the ESA for your child up to the day prior to his or her 18th birthday. Moreover, if the funds are not withdrawn by the age of 30 of the beneficiary, certain tax penalties may apply.
Since 2002 when changes to the ESA were made, qualified educational expenses no longer only included college expenses but also included educational expenses related to grades K-12.
There is no limitation on the amount of children that you open an ESA for; however, only the maximum allowable funding is allowed for each child per year, which is $2,000. (Please check into the allowable amount as the amount could change with time.)
The amount specified above may change after 2010, as will some other benefits of the ESA unless the Congress votes to keep the current ESA benefits and requirements. Otherwise, the contribution amount will drop $1,500 to $500 and expenses from grades K-12 will no longer be qualified expenses.
Remember, before opening an educational IRA, or ESA, be sure to read all the terms first. There are requirements that have to be met on a yearly basis when making contributions as well as the year that the beneficiary of the account plans to withdraw the funds that have been contributed.
As always, before deciding with any kind of plan, do thorough research first. Make sure you know what you are getting into and that you won’t regret it later. Educational IRA’s are a great thing for your children’s educational expenses. If saving for your kids education is on your mind, check out our UPromise review to see how you can get free money for college for things you may buy already.