Education Savings Account - Educational IRA

An education savings account (ESA) is designed to help families save for their child's educational expenses, whether it be for grade school, private school, or college.  An education savings account is a tax advantaged investment account allowing families to make and grow investments at a tax-free rate.  When the funds are withdrawn to cover the educational related expenses, they are also withdrawn tax free.  Contribution into the account is at the sole discretion of the contributor; however, there are maximum annual limits associated to this plan.

Who is Eligible to Contribute to an ESA?

In order to be eligible to make the full contribution of $2,000 to this plan, the contributing party must have a modified adjusted gross income (MAGI) of less than $95,000 if they are filing as single, and $190,000 if they are filing jointly.  For those individuals who have a MAGI between $95,000 and $110,000 & couples who between $190,000 and $220,000, a partial contribution is eligible.  To avoid these rules, a corporation is allowed to make tax free contributions on the employees behalf, regardless of income level.

An ESA is eligible to receive contributions as long as the child whose name is beneficiary of this plan is under the age of 18.  Conversely, the account must make full distribution if the beneficiary dies or reaches the age of 30, whichever comes earlier. If distribution is made after the age of 30, income taxes and a 10% penalty will apply to the gains made in that account.

Contribution Deadline

Contributions for the current calendar year must be made by the April 15 tax deadline in the following calendar year.

ESA Qualified Expenses

A qualified education expense in the eyes of ESA is an expense that is required for enrollment or items which would support the attendance of a school.  These can include books, tuition, equipment & supplies, room & board, and any other fees associated to attending shool. 

In the event that more cash is withdrawn than actually needed for these qualified expenses, the excess distribution will be taxed and subject to a 10% penalty, unless you are receiving a scholarship or die.

How is the ESA different than a 529 Plan?

The major difference lies in the contribution limits of $2,000 for the ESA compared to a 529 plan which has no contribution limits other than the lifetime limit.  Secondly, the ESA allows for more flexibility around which types of learning institutions are acceptable; 529 plans are only eligible for accredited colleges.  Finally, there are no age limits on a 529 plan as there are for ESA's.  This can be an issue for those going to medical school or going for PhDs. 
Tim Ord
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