A number of publications, including my own, have mistakenly reported over the past year that Coverdale IRAs, formerly known as Education IRAs, are tax deductible. Coverdale IRAs are not tax-deductible.

Originally the concept of education IRAs was meant to provide a tax-deductible benefit that would defer taxes on contributions until the time of withdrawal, but the accounts were limited in size to only $500 per year. Due to the small allowable account size, these Education IRAs were not very popular with savers of financial institutions. Then in 2001 the amount of the allowable contribution was increased to $2,000 for individuals with an income up to $95,000 or couples filing jointly with an income up to $190,000. But the contribution is not deductible from taxable income for federal income tax purposes in the same manner as a traditional IRA account.

One possible work around to achieve the immediate tax deferral benefit of deductibility is to make a regular tax deductible IRA contribution if you qualify, and then make a penalty-free withdrawal for education purposes in a later year. Education expenses are one of the special IRA withdrawals allowed that are exempt from early withdrawal penalties.

This tax issue aspect is separate and distinct from the issue of tax credits for higher education known as the lifetime learning credit and the Hope Scholarship credit. The tax credits have their own rules. Also, Section 529 tuition plans offer additional tax deferral alternatives.

One common theme in all of these plans is that upper income taxpayers cannot effectively use these tools to reduce their current tax bill. These built-in income limitations plus the effect of alternative minimum tax rules make these tools ineffective for current-year planning, but can still have a significant tax effect over a longer period of time. Upper income taxpayers should consider the use of various types of trust accounts for more effective income tax planning strategies.

For more information on this topic, the IRS has a well-written Publication 970 titled Tax Benefits for Higher Education. This is available by calling 1-800-TAX-FORM or on the Web at www.irs.gov/pub/irs-pdf/p970.pdf.