Parents paying and saving for their children's college bills reaped the benefits this tax season of a new batch of education breaks that took effect in 1998. But a significant twist in the new law has gotten little notice.
Education IRA rules restrict parents from participating if their joint income exceeds $160,000 ($110,000 for singles). But nothing prevents a child from funding his or her own education IRA, the law says it is the contributor who must meet the income restrictions. A child doesn't have to have income or file a tax return to be eligible--the money can be a gift from you.But getting a bank, broker or mutual fund to go along may be tricky. Mike Goble, a computer engineer in Los Altos, Calif., tried to set up education IRAs with American Century into which his 20-month-old twins would make contributions for each other (also acceptable under the law). But the fund company told Goble that, as minors, the twins couldn't own their own accounts and that it would open education IRAs only for existing customers, Goble succeeded with Schwab, where he did have existing accounts in the children's names, Goble serves as custodian, but the twins contribute to their own education IRAs.
Though they're probably not who congress had in mind, upper-income families are the best candidates for education IRAs. Parents who earn more than $100,000 filing jointly or $50,000 filing single returns forfeit the Hope and Lifetime Learning tax credits in any year they use proceeds from an education IRA. Thus, if you expect to exceed the income limits when your children are in college, you might as well take advantage of an education IRA.
You could use both the education IRA and a tax-deffered state sponsored college savings plan by funding the state plan with a lump sum and an education IRA with the $500-per-year maximum. You cannot contribute to both in the same year.
If you do expect to qualify for the tax credits when your children are in college, skip the education IRA in favor of the tax credits. You can still invest in a state plan without jeopardizing the credits.