Education savings accounts are actually tax-deferred accounts used to pay for education expenses. You can contribute up to $2,000 in a year to each child's education savings account until the child reaches age 18. A child may have more than one education savings account, but combined contributions to all accounts in one year may not exceed $2,000.
Withdrawals that are in excess of qualified expenses are taxed at the beneficiary's tax rate. Similarly, you generally owe a 10% penalty on withdrawals that exceed the amount of qualified expenses.
Contributions to an education savings account are subject to income limits. If your modified adjusted gross income (MAGI) is above the lesser amounts shown below, your allowable contribution is reduced, or phased out. You can still make an allowable contribution of less than $2,000. If your MAGI exceeds the larger amounts shown below, however, you are not allowed to contribute to an education savings account for the current year.
You may wish to keep in mind the following about education savings accounts:
- Withdrawing leftover funds. Assets left in an education savings account must be used within 30 days of either: a) the beneficiary reaching age 30, or b) the beneficiary's death (unless a special-needs situation applies or the account is rolled over to a family member).
- Rollovers. If you decide to transfer the assets of an education savings account to a new beneficiary, you have 60 days to complete a rollover to avoid triggering a tax bill. (A similar 60-day rule applies when rolling over regular and Roth IRAs.)
- Using an education savings account with other tax-advantaged accounts. As a result of the 2001 tax law, beneficiaries may use education savings accounts together with the Hope credit, lifetime learning credit, or a Section 529 plan. However, you can't pay for expenses with a tax-advantaged account and take a credit for the same expenses.
For more information on education savings accounts, see IRS. Pub. 970: "Tax Benefits for Education."
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.
Next, we'll take a look at using regular IRAs, Roth IRAs, or 401(k) plans as a source of money to pay for college.