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Individual Retirement Accounts

Education Ira

The education IRA, although similar to a Roth, has several important differences. Like the Roth, the education IRA does not provide a current tax deduction but does allow for tax-free growth of the investment principal, and has the same phaseout rules for allowable contributions. The purpose of the education IRA is to save for qualified higher education expenses for the named beneficiary. These expenses include tuition, fees, books, and room and board for students enrolled at least half-time, and as of 2002 will also include expenses for elementary and secondary schools. The contributions to this IRA must be made before the beneficiary reaches eighteen years of age and must be made in cash. The cash stipulation differs from other IRAs, for which the contributions can also be in the form of securities. Another important difference is that the contribution for an education IRA cannot exceed $500 per year per child. However, this limit increases to $2,000 after 2001. Excess contributions face the same rules as the Roth IRA, but if there are contributions made on the child's behalf to a qualified state tuition program, such as a Section 529 plan or prepaid tuition plan, then any amount contributed to the education IRA is considered excess. Excess contributions must be withdrawn by year-end or face a 10 percent penalty.

The distributions from an education IRA in any year cannot exceed the amount of qualified higher education expenses. Otherwise, the same rules apply for withdrawal and bequests that exist for traditional and Roth IRAs. The only exception is that the funds must be distributed by the time the beneficiary is thirty years old or, if the beneficiary dies, the assets must be distributed to that person's beneficiaries within thirty days from the time of death. If the person is a minor or does not have a will then state laws of intestacy will dictate the beneficiary.

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