An education IRA may be opened on behalf of a minor under the age of 18. Contributions are set at a maximum of $2,000 (per child, per year) and are not tax deductible, nor can they come from pre-tax dollars. The savings account then grows tax-free until the time of distribution.
If the funds are used for educational-related expenses, including tuition, fees, required books, computers and/or room and board, the distribution is also tax free. If the distribution amount exceeds the cost of educational expenses, or the funds are used for non-educational expenses, the earnings on the account will be considered as regular income and will be taxed accordingly, along with an additional tax of 10%.
Education expenses are not limited to college and university costs, and can include elementary and secondary school, vocational and other qualified post-secondary institutions, as well as higher education. Contribution limits exist for taxpayers based on their Modified Adjusted Gross Income (MAGI).
If the beneficiary does not redeem funds before the age of 30, the account must be distributed within 30 days or be subject to taxation. Taxes may be avoided, however, if the full balance is rolled over into a new education IRA for another family member.
The earnings in a 529 plan are exempt from federal and state income taxes, provided the money is used for qualified educational expenses. Any other withdrawals are subject to taxes plus a 10% penalty, with exceptions for certain circumstances, such as death or disability.
As with other kinds of investing, the earlier you get started, the better. With a 529 savings plan, your money will have more time to grow and compound. With a prepaid tuition plan, you'll most likely be able to lock in a lower tuition rate, since many schools raise their prices every year.
Starting in 2023, the IRS allows for an exclusion from the gift tax of up to $17,000 per person for a qualifying gift, including gifts to minors. The UTMA provides for a convenient way for children to save and invest without carrying the tax burden. The minor’s Social Security number is used for tax reporting purposes on UTMA accounts. It is also important to note that because assets held in a UTMA account are owned by the minor, this may have a negative impact when the minor applies for financial aid or educational scholarships.
The Act allows the donor to name a custodian, who has the fiduciary duty to manage and invest the property on behalf of the minor until the minor becomes of legal age. The property belongs to the minor from the time the property is gifted. If the donor dies while serving as custodian, the value of the custodianship property is included in the donor’s estate.