Educational Custodial Funds

The IRA education is an individual retirement account that has nothing to do with retirement. Even though its name includes the initials IRA, it's not an IRA. Instead, it's a kind of savings account that offers tax benefits if you set aside money to help pay for a child's (or grandchild's) college education.

Here, in a nutshell, is how it works: Once you set up an Education IRA _ at a bank, brokerage or mutual fund company, for example _ you may contribute up to $ 500 in cash each year per child (until the child turns 18). When the time is right, you withdraw the money to help pay for a child's or grandchild's college expenses.

In some ways, Ira education expenses are more like the new Roth IRAs than traditional IRAs. For instance, you can't claim a federal income tax deduction for the money you contribute. But the money does grow on a tax-favored basis. In other words, all the money your Education IRA earns each year - whether it's in the form of interest or dividends, for example - doesn't get nicked by the tax man every year, as it would if it you had set the money aside in an ordinary bank account, or in certain types of brokerage or mutual fund accounts. And when you withdraw the money, it doesn't get taxed, as long as you meet the rules.

Whether you can contribute depends on your income:

* If you're single and your adjusted gross income is less than $ 95,000, you may contribute the full $ 500 per year per child. If your adjusted gross income is between $ 95,000 and $ 110,000, you may make partial contributions. If it's $ 110,000 or more, you can't contribute.

* If you're married and filing jointly, and your adjusted gross income is less than $ 150,000, you may contribute the full $ 500 per child. If it's between $ 150,000 and $ 160,000, you may make partial contributions. If it's $ 160,000 or more, you can't make contributions.

The income limits apply to the person contributing the money, not to the beneficiary. But unlike with a traditional IRA (or a Roth IRA), you don't need to have earned income (from a job) in order to contribute to an Education IRA; your beneficiary doesn't need to have earned income, either.

The Education IRA is kind of like a trust or custodial account that you set up to help pay for a child's "post-secondary" education. So you can't spend the money to send the child to a private elementary school or high school. But you can use it to send a student to a college or university. As long as you meet these rules, money that's withdrawn from an Education IRA won't be taxed.

What if the student graduates and there's still money left over in the Education IRA? The law requires that the money be pulled out within 30 days after the beneficiary reaches age 30. And at that point, the beneficiary will have to report the earnings as income, making it subject to income tax. The beneficiary will also have to pay a 10 percent penalty on the earnings.

Education IRA