Education IRAs, formally known as Coverdell Education Savings Accounts, are uniquely designed to help investors save for education expenses. All other types of IRAs are technically non-education IRAs, as they do not have these unique education provisions. The specific types of IRAs falling into this category are Traditional IRAs, Roth IRAs, SEP IRAs and SIMPLE IRAs.
IRA Purposes
Most IRAs are designed for long-term retirement savings. However, money within an IRA can be accessed at any time for any purpose, as long as you are willing to pay any applicable taxes or penalties. Although Education IRAs do offer tax- and penalty-free withdrawals for educational purposes, even Traditional IRAs offer penalty-free withdrawals if you are using the funds for qualified higher education expenses, as defined in IRS Publication 590.
Contribution Limits
Every year the IRS publishes limits on contributions to IRA accounts. For 2010, Roth and Traditional IRA contributions are capped at $5,000, or $6,000 if you are age 50 or older. Contributions to SIMPLE IRA accounts are limited to $11,500, $14,000 if you are age 50 or older. SEP IRA contributions are limited to 25 percent of your compensation, up to a limit of $49,000.
Contribution Deductibility
Contributions to most non-education IRAs are deductible, as long as the IRA if your only retirement plan. Deductible contributions are not included in your income and therefore are not taxed. If you are covered at work by another retirement plan, such as a 401k plan, the deductibility of your contributions is determined by a combination of your tax filing status and your modified adjusted gross income. IRS Publication 590 provides a matrix to help you calculate your contribution deductibility. Roth IRAs differ from other non-education IRAs in that you can never take a deduction for a Roth contribution, as they are funded with after-tax dollars only.
Required Minimum Distributions
Except for Roth IRAs, the IRS requires mandatory distributions from all IRAs once you reach the age of 70 1/2. Every year, this RMD amount must be recalculated based on your account value and your life expectancy, as defined by the IRS in Appendix C of Publication 590.
Taxation of Distributions
As all IRAs except Roth IRAs are funded with pre-tax dollars, all IRA distributions are taxable at ordinary income tax rates. Roth withdrawals are tax-free.
Penalties
IRA contributions in excess of IRS-approved limits are subject to a 6 percent penalty tax. IRA withdrawals before you reach age 59 1/2 incur a 10 percent penalty tax, subject to exceptions found in IRS Publication 590. If you do not take out a required minimum distribution, you must pay a 50 percent penalty tax on the amount you did not withdraw. Roth IRA distributions taken within 5 years of the establishment of the account are subject to a 10 percent penalty, in addition to ordinary income tax on the earnings portion of the withdrawal.
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