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Updated December 7, 2020

What is an Education IRA?

An education IRA, now more formally known as a Coverdell Education Savings Account (or Coverdell ESA), is a tax-advantaged savings account intended to help parents and guardians prepare for the expense of their child’s education.

How Does an Education IRA Work?

An education IRA may be opened on behalf of a minor under the age of 18. Contributions are set at a maximum of $2,000 (per child, per year) and are not tax deductible, nor can they come from pre-tax dollars. The savings account then grows tax-free until the time of distribution.

If the funds are used for educational-related expenses, including tuition, fees, required books, computers and/or room and board, the distribution is also tax free. If the distribution amount exceeds the cost of educational expenses, or the funds are used for non-educational expenses, the earnings on the account will be considered as regular income and will be taxed accordingly, along with an additional tax of 10%.

Education expenses are not limited to college and university costs, and can include elementary and secondary school, vocational and other qualified post-secondary institutions, as well as higher education.

Contribution limits exist for taxpayers based on their Modified Adjusted Gross Income (MAGI). For single filers, the modified adjusted gross income limit is $110,000, and $220,000 for joint filers.

If the beneficiary does not redeem funds before the age of 30, the account must be distributed within 30 days or be subject to taxation. Taxes may be avoided, however, if the full balance is rolled over into a new education IRA for another family member.

Why Does an Education IRA Matter?

Higher education is a major concern for families, the cost of which continues to rise (particularly where private schools and colleges are concerned). Education IRAs provide parents and their children the opportunity to start saving for educational expenses when their children are still very young. This way, contributions invested in the account have more time to grow with the benefit of compounding interest.

InvestingAnswers Feature: College Tuition: 5 Ways to Save on Education Expenses

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