The goal of an “Education IRA” is to create an account into which funds can be placed and withdrawn, tax-free, for the purposes of education. The tag of IRA is a bit misleading since these accounts are not intended, nor are they available for, use as retirement funds. The account is fed by parents, grandparents and others and eventually is used to pay for a child’s education upon entering college. The IRS has officially changed the name of such accounts as of 2002 and they are now called Coverdell Education Savings Accounts (ESAs).
Among the restrictions on ESAs are income limits for the contributors. The modified adjusted gross income of a contributor may not exceed $100k or $200k annually for those filing jointly. The anticipated beneficiary may also make contributions to the account up until they reach the age of 18.
The maximum contribution that a parent or parents can make each year is $2,000. The contribution is not tax deductible, but the account itself grows tax free until the time of distribution. After distribution the funds may not be taxed either, as long as the total amount distributed does not exceed the tuition and expenses approved by the specified school. Excess funds removed from the ESA are taxed at 10%.
While traditionally used for higher education, the funds in an ESA can be used to pay for elementary and secondary schools as well as vocational education. Tuition, fees, books, supplies and room and board can all be covered.
If the monies in an ESA are not used by the time the beneficiary reaches the age of 30 the money must be distributed within 30 days. Earnings are taxed 10% when withdrawn, but the funds may be rolled over to another ESA for another family member instead to avoid the taxes.