Education IRAs

A third type of tax break for educational expenses is the Coverdell education savings account (ESA), formerly known as an education IRA. "IRA" was something of a misnomer because this type of account is not designed to survive into the beneficiary's retirement. However, the account works similarly to a Roth IRA in that contributions are not deductible, but interest and dividends that build up within the account are tax-free, and amounts withdrawn from the account under proper circumstances will not be taxed.

ESAs are set up on a per-child basis, with a bank or other financial institution approved by the IRS. Each child must have one or more separate accounts, and the child, a parent, grandparent or friend may contribute up to $500 to the account in 2001 ($2,000 in 2002). More than one person can contribute on behalf of the same child, but the total contributions for that child cannot exceed $500. No contributions can be after the child turns 18, and no contributions can be made in the same year that a contribution is made to a qualified state tuition program on behalf of the child.

• There are income restrictions on the persons who are able to contribute to education IRAs.
• Distributions from ESAs are not taxed if spent on qualified expenses; accounts can be rolled over to family members; if not spent or rolled over, the accounts must be distributed within 30 days after the beneficiary reaches age 30.