Education IRAs
Dripping for Junior's Schooling

by Vince Hanks (TMFElwood@aol.com)

NORTHVILLE, MI (Dec. 10, 1998) --

"If you think education is expensive, try ignorance."

- Derek Bok, former President of Harvard University

Many of us are Dripping away our savings not only for our own future (lounging on island beaches while sipping fruity concoctions decorated with bamboo umbrellas. Can't forget the bamboo umbrellas!), but also for the futures of the young loved ones in our lives. Those futures will most likely include a college education and -- guess what? College ain't cheap! There is a vehicle that can help you save for the cost of higher learning, though.

The 1997 Taxpayer Relief Act created a unique investment vehicle with a curious name. It sounds like one of the singing characters from Schoolhouse Rock that educate us to the rhythm of snappy tunes on Saturday morning. Move over Lucky Seven Sampson, Education Ira is here!

The Education IRA is not an individual retirement account (IRA) at all. It has nothing to do with retirement savings; rather it provides a vehicle to save and grow money tax-free for the purposes of post-secondary education. The Education IRA allows you to invest up to $500 a year for each child younger than 18, depending on your income level. If you're single and your annual income is less than $95,000, or married with a combined income less than $150,000, you can contribute the full $500. The contribution limit gradually falls as income increases, until a ceiling is reached ($110,000 for single, $160,000 for married), at which point you can no longer add funds.

One of the nice things about the Education IRA is anyone can contribute -- friends, relatives, Penn & Teller -- it doesn't matter, as long as the total amount invested per child doesn't exceed $500. Regardless of who contributes, the funds are controlled by the parents, with the child named as the beneficiary, until the funds are distributed or the child reaches the age of 30.

Like the Roth IRA, contributions to the Education IRA are not deductible. Earnings grow tax-exempt, and withdrawals for qualified higher-education expenses are also free of the Taxman's bailiwick. Qualified expenses include textbooks, room and board, and tuition, if used before the beneficiary's 30th birthday. If those requirements are not met, you will pay taxes on earnings in the account, plus an additional 10% penalty.

So, what if in the meantime Junior starts his own Internet company, goes public, develops a personal worth twice that of Zimbabwe's Gross National Product and decides maybe he'll just skip college altogether (we'll assume he's also a selfish brat that won't reimburse you a dime)? Not to worry. Any unused funds may be rolled over to another child under the age of 18 without penalty.

If you think the limit of $500 annually is rather stringent (and I agree), there may be hope on the horizon as lobbying efforts to raise the minimum to $2,000 are underway. Even if these efforts do not succeed, $500 growing tax-free annually is worth the very little effort it takes to set up an account for prospective academicians.

If your income is above the prescribed limits, there is a way you can still contribute to the education of a child. Remember that a tax-free gift of up to $10,000 per year can be given to anyone. You can gift money to a friend or relative, who in turn can invest on the child's behalf in an Education IRA, providing his or her income levels are within the allowable parameters.

Education IRAs are beginning to emerge among the dividend reinvestment plans that offer in-house IRA options and several more have plans to add it in the near future. If you can't find a suitable Drip, another option is to find an institution willing to act as a custodian for the IRA and allow fee-free Dripping. This can be difficult since the broker will not stand to generate any fees or commissions from future contributions. Non-Drip Education IRAs should also be a consideration.

One final note about changes in the tax laws. Beginning in 1998, withdrawals from traditional IRAs for the purposes of qualified higher-education expenses for yourself, spouse, child, or grandchild, are not subject to the normal 10% early withdrawal penalty. These withdrawals are, however, subject to income tax.

If you have questions and comments about Education IRAs or Drip investing in general, please drop by the Drip message boards. Also, check out these recent articles in our tax area on Education IRAs: Education IRA and Education Credits and Deductions.

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FoolWatch -- It's what's going on at the Fool today.

12/10/98 Close
Stock Close Change JNJ 79 - 7/8 INTC 114 5/8 -4 9/16 CPB 55 11/16 -1 3/16 MEL 65 11/16 - 1/8
Day Month Year History Drip (2.34%) 1.57% 29.64% 10.40% S&P 500 (1.56%) 0.11% 20.05% 22.46% Nasdaq (1.68%) 3.41% 28.38% 26.49% Last Rec'd Total # Security In At Current 11/02/98 8.055 CPB $52.880 $55.688 09/01/98 9.727 INTC $80.238 $114.625 11/09/98 8.578 JNJ $74.090 $79.000 10/07/98 1.000 MEL $48.560 $65.688 Last Rec'd Total # Security In At Value Change 11/02/98 8.055 CPB $425.95 $448.56 $22.61 09/01/98 9.727 INTC $780.50 $1115.00 $334.50 11/09/98 8.578 JNJ $635.55 $677.66 $42.12 10/07/98 1.000 MEL $48.56 $65.69 $17.13 Base: $2200.00 Cash: $262.88** Total: $2569.79

The Drip Portfolio has been divided into 93.111 shares with an average purchase price of $23.628 per share.

The portfolio began with $500 on July 28, 1997, adds $100 on the 1st of every month, and the goal is to have $150,000 in stock by August of the year 2017.

**Transactions in progress:
10/24/98: Sent $40 to buy more INTC.
11/24/98: Sent $100 to buy more MEL