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Consider Income Rules Before Funding Education IRA for College-Bound Child

October 08, 2000|LIZ PULLIAM WESTON

Q: My wife and I read with interest your recent comments about the education IRA. We have been placing the maximum $500 a year into education IRAs for our two daughters. From what you wrote, one of the major disadvantages of the education IRA seems to be that you cannot withdraw money for college expenses and take a education credit in the same year. While we agree that the Hope Credit and Lifetime Learning Credit can be valuable for middle-income families, because they directly reduce federal income taxes, our incomes are likely to be well over the $100,000 limit to take those credits. Shouldn't we continue funding the education IRAs?

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A: Possibly. But another potential reason not to fund an education IRA is that it would prevent you from contributing to a state-sponsored college savings plan in the same year.

I've talked about the advantages of these plans in past columns, but essentially they allow you to put money into a tax-deferred account, typically one that's invested in a mix of stocks, bonds and cash. The money, when withdrawn, is taxed at the child's tax rate, usually 15%.

Unlike education IRAs, which are capped at a measly $500 per child per year, many state college savings plans allow total contributions of $100,000 or more. In addition, these plans have powerful estate-planning advantages, and the contributor controls who gets the money. (That's different from custodial or Uniform Gift to Minors Act accounts, in which the child gets control of the money at a certain age.)

For more information on college savings plans, visit the College Savings Plan Network at http://www.collegesavings.org, or accountant Joseph Hurley's site at http://www.savingforcollege.com. Start with his FAQ (frequently asked questions) link to get a good overview of how the plans work.

If you decide a college savings plan is not for you, and your incomes are likely to be over the limit for taking an education credit (the limits are $50,000 for singles and $100,000 for married couples filing jointly), then you might as well fund an education IRA. Even though the limit is low, the money is tax-free if used for college expenses.

A Painful Lesson for Investor

Q: On Labor Day, I placed an order to sell shares of a mutual fund. Between the time I placed the order and the time the shares were actually sold at the end of the next business day, the shares declined 3% in value. I'm assuming brokerages are allowed to do this, but is there any class-action lawsuit I could join to force brokerages to place the order as soon as possible so that this wouldn't happen?

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A: Perhaps we should mount a class-action lawsuit against investors who refuse to learn the basics before making trades.

Most mutual funds don't trade the way stocks do. While stocks can be bought and sold throughout the day, mutual funds are bought and sold based on their net asset values (NAV) at the end of the day. Basically, the net value of all the fund's holdings are divided by the number of shares outstanding to determine this NAV. Since you placed your order on a holiday and you received the NAV as of the end of the next business day, there was nothing improper in the transaction--it happened exactly as it was supposed to.

It's natural to be confused by the machinations of the markets, particularly when you're new to investing. It shouldn't be natural to seek out a lawyer before you crack open a personal finance book or check out one of the many investing tutorials available online. You'll find good information at http://www.latimes.com/invest101 and at Vanguard Group's Plain Talk library at http://www.vanguard.com. You might also check out my colleague Kathy Kristof's new book, "Investing 101," published by Bloomberg Press.

Getting More for Your Money

Q: I just had to write you a line to say, "Right on!" about your advice to the daughter with a spendaholic father. I especially liked your suggestion that she attend Al-Anon meetings. She's probably heard that suggestion before, as her father has been sober for more than 20 years; perhaps the denial she wrote about is as much hers as his. In any case, I wanted to congratulate you for "crossing the line" and giving more than financial advice.

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A: Yup, we here at Money Talk live to "cross the line," which tends to confuse innocent readers who think they've happened upon just another financial question-and-answer column. I heard from several other readers who are also having problems with their elderly parents' spending. Although alcoholism and alcoholic behavior isn't always a factor, many people might be helped by Al-Anon's "let go" message.

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Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times' Web site at http://www.latimes.com/moneytalk.

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