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EDUCATION IRAS ARE TOO MINIMAL, TOO FLAWED TO BE OF MUCH USE

Education IRAs are not really a good deal for college saving.

You can contribute only a total of $500 each year per child. So if Grandma sets aside $500 for a child, Mom and Dad can't do the same for that child during the same year, says Joe Hurley, a certified public accountant and editor of "The 529 Plan Report."

Education IRAs can carry a sizable maintenance fee of $10 to $20 per year, because financial institutions aren't eager to handle paperwork for such small investments. In the first year, a $500 Education IRA would have to earn 4 percent just to pay for a $20 fee.

Saving for a child's college costs requires much larger contributions than $500 a year. A four-year public college education of a baby born this year - including tuition, room and board - will cost about $115,000. That will require saving at least $200 a month.

But the IRS prevents people from saving in more effective, tax-advantaged ways if anyone in the family contributes to an Education IRA in a given year. For example, if Grandma puts $500 a year into an Education IRA this year, parents can't put money into a 529 state tuition program for the year.

The 529 state tuition programs allow much larger savings, and the money can build on a tax-deferred basis until a child goes to college. Each year, individuals can put $10,000 a year into them for a single child. So this year, a mother and father could put away a total of $20,000 and grandparents could put $500 into a 529 plan instead of an Education IRA.

If Mom and Dad aren't communicating well with Grandma, and she puts money into an Education IRA without telling the parents, the grandchild could eventually confront a huge penalty if parents also invest in either an Education IRA or a state tuition program during the same year.

The child will face an excise tax for each year since the mistake was made. So if the mistake was made the first year of a child's life, and not discovered until college, the child could face an "excess contribution" penalty of 6 percent for all 18 years.

Parents may have additional reasons to regret opening an Education IRA once the child is in college. When parents with incomes under $100,000 start paying for tuition, the IRS gives them tax credits - as much as $1,500 a year, depending on income. But if the child uses an Education IRA to pay for college, the parents won't be allowed to take the tax credit for that year.

"The chances are that the tax credits (the Hope or Lifetime Learning Credits) will be more valuable than the tax exemption of an Education IRA withdrawal," says Hurley.

He also notes that an Education IRA prejudices a student's eligibility for financial aid - even when education savings fall far short of covering the cost of tuition, room and board. That makes Education IRAs a particularly poor investment for low- and moderate-income people.

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