How An Education IRA Works

Parents who are interested in investing some money as a way to save money for their children to use for college expenses should consider opening an Education Ira for each of their children. These accounts, also know as Coverdell Education Saving Accounts (ESAs) are a way to start saving toward college without having to pay taxes on any earnings as long as they are used properly.


Each year parents and other interested parties can contribute up to $500 per tax year into these investment accounts, and not have to worry about paying taxes on any money earned through the investments made. The exact amount that someone is allowed to contribute to an Education Ira depends on the amount of money that the person makes, with those making over a certain amount either only allowed to contribute a lesser amount or nothing at all to this type of account.

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The limit is $160,000 adjusted gross income for married taxpayers filing jointly, and $110,000 adjusted gross income for individuals. Even if parents make too much money to contribute, it still might make sense for an account to be opened since other people, including grandparents, other relatives, friends, and children themselves can still contribute.

When it comes time for the child to go to college, the earnings from the Education Ira accounts will still be tax free as long as withdrawals do not exceed the expenses of the child for his or her education. It doesn't matter whether the child is going to school full time or part time, the money can still be used without taxation as long as the child doesn't withdraw extra from the account.

If the child does withdraw extra from his or her Education Ira, any earnings will be taxed, with an additional ten percent penalty added. It is best to make sure that you don't withdraw more than you need to cover expenses in order to avoid this.

Should a child decide that they don't want to go to college, the money in the account can be rolled over into the account for another child who does want to go to college (or might want to when they are old enough), or, if this is not an option, it can be taken out and used by the individual named on the account. However, the child will then have to pay taxes on any earnings as well as the ten percent penalty. At least these taxes will be calculated at the child's tax rate rather than the tax rate of the contributors.



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