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Educational Expenses and IRA

The expenses for higher education have continually increased over the years, and this increase is the reason for the establishment of the educational IRA. However, the educational IRA is not as simple as it may initially sound, like most government sponsored and approved savings plans. There are many special qualifications and stipulations that state exactly how the educational IRA works and can be used, and to get the most out of an educational IRA it is important to know and understand all the little details. Although the IRA has many caveats that may not be in one’s favor, with enough knowledge the system can be manipulated to turn the tables and result in a positive situation for the investor.

Educational IRA: The Regulations

An educational IRA is, at its core and most simplistically stated, a savings plan to help build a sum of money to cover the expenses of college or higher education. The primary benefit of the educational IRA is that the money that is withdrawn later to cover educational expenses is tax-free. However, this is precisely the point where all the detailed stipulations come into play because if the government is going to allow you to not pay taxes, they are going to heavily regulate the process so that in many cases the money ends up being taxable after all.

The first requirement of the educational IRA is that money can only be added to the IRA until the intended recipient turns 18. After he or she is 18, all contributions must stop, but the money does not have to be withdrawn until thirty days after the person’s thirtieth birthday. All contributions to the IRA must be made in cash, and there is a maximum of $500 allowed per year. This limit does not mean that one parent can contribute $500, the other parent $500 more and a grandparent or two also $500; it means $500 total per IRA. However, this limit is overshadowed by additional stipulations, as well. The maximum amount of $500 is allowed only when the contributor’s adjusted gross income is less than $95,000. When the AGI exceeds this amount, the amount that is allowed to be added to the IRA decreases on a proportional scale.

Once the money is ready to be removed from the IRA, the law states that the money is only exempt from taxes if used for educational purposes and if the educational expenses equal or exceed the amount withdrawn. If other scholarships are received and not all of the money in the IRA is needed to cover expenses, the money will become taxable 30 days after the recipient turns 30 unless the money is transferred into a new IRA for someone else who is under the age of 18. Although there are many strict regulations governing the educational IRA and its tax-free status, a knowledge of the rules and how it works will enable people to take full advantage of the system and ensure that the money is used to decrease personal educational expenses and remains tax-free.

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