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Saving Money For College

You and your family can create a Coverdell Education Savings Account (formerly an Education IRA) and make penalty-free withdrawals from other IRAs to help pay for your education.

Taxpayers may withdraw funds from an IRA, without penalty, for their own higher education expenses or those of their spouse, child, or even grandchild. Usually, if you withdraw funds from an IRA before you're 59-1/2, you must pay an additional 10 percent tax on the withdrawal amount. This 10 percent tax is waived on a withdrawal used for qualified expenses of the student.

In addition, for each designated beneficiary under age 18 or a special needs beneficiary, families may deposit up to $2,000 per year into a Coverdell Education Savings Account in the child's name. Earnings will accumulate tax-free. No taxes will be due upon withdrawal if the money is used to pay for postsecondary tuition and required fees, books, equipment, and eligible room and board expenses. Once the beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary, the account must be closed or transferred to a younger member of the family.

A taxpayer's ability to contribute to a Coverdell account is phased out when the taxpayer is a joint filer with a modified adjusted gross income of $220,000, or a single filer with a modified adjusted gross income of $110,000.

Note: A student who receives a tax-free distribution from a Coverdell account can also benefit from the American Opportunity, Hope or Lifetime Learning education tax credits in the same year. For more information on these tax benefits, read IRS Publication 970, Tax Benefits for Higher Education. You can also consult your tax advisor.

Greater Flexibility For Families
Saving In Qualified Tuition Programs

A qualified tuition program (QTP) allows family members to either prepay, or contribute to an account established for paying, a student's qualified higher education expenses at an education institution eligible to participate in U.S. Department of Education student aid programs. Both states and eligible institutions can establish and maintain such programs.

When a family uses a qualified state-sponsored tuition program to save for college, no tax is due in connection with the plan either as funds accumulate or at the time of withdrawal, as long as the distribution is less than the beneficiary's adjusted qualified higher education expenses. The same is true for institution-sponsored QTPs, except that only earnings distributed after January 1, 2004 are not taxable.

Families may use QTPs to save for tuition, required fees, books, supplies, equipment, and eligible room and board expenses. A Hope, American Opportunity, or Lifetime Learning Credit can be claimed in the same year the beneficiary receives a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits.

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