Education IRA

Through the Education IRA, a taxpayer can invest up to $500 on an after-tax basis per child. Contributions must stop when a child reaches age 18. Earnings accumulate tax free, and money withdrawn to pay for qualified education expenses (tuition, fees, books, equipment, room and board) is tax free. By the time the child reaches age 30, money must be transferred to a younger beneficiary or be withdrawn, otherwise subjecting the earnings to tax and a 10 percent penalty. While more than one person can contribute to an Education IRA for a child, no more than $500 for that child can be saved in any year. Taxpayers cannot take a tax-free distribution from an Education IRA in a year when they use either education tax credit. Also, if the taxpayer contributes to a qualified state tuition program for a child, then no Education IRA contributions for that child can be made in that year.

Roth IRA

The Roth IRA is another after-tax savings option, with an annual maximum contribution of $2,000 per year for single taxpayers and $4,000 for couples filing jointly. These maximums are reduced by amounts contributed to a deductible IRA. Earnings accumulate tax free and contributions can continue beyond age 70 ½. Distributions from a Roth IRA are tax free if make five years or more after the taxpayer established the Roth IRA and the taxpayer is age 59 ½ or older, or upon disability or death, or to cover the costs of first-time homebuyer expenses, up to $10,000. Withdrawals for education expenses have no special provision bur are tax free as long as the taxpayer maintained the Roth IRA for at least five years and is age 59 ½ or older.

Who Can Contribute to New After-Tax IRAs?

Married couples with an AGI under $150,000 and single taxpayers with an AGI under $95,000 can contribute the maximum to either or both after-tax IRAs. At higher income limits, the amount that can be contributed to these IRAs phases down gradually until married taxpayers with an AGI $110,000 cannot contribute to either account.

Penalty-Free IRA Withdrawals

Starting on January 1, 1998, individuals can withdraw funds from IRAs to pay for tuition, fees, books, and if enrolled at least half-time, room and board without facing the 10 percent penalty for early (before age 59 ½) withdrawals. Taxpayers can use these funds for their education expenses or those of their spouses, children, and grandchildren. Taxpayers making withdrawals from traditional before-tax or rollover IRAs would have to pay income tax on the full amounts withdrawn but no penalty tax.