PATH Act Expands Penalty-Free IRA Distributions for Education | Ed Slott and Company, LLC

PATH Act Expands Penalty-Free IRA Distributions for Education

By Sarah Brenner, IRA Analyst
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As 2015 draws to a close, the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) was signed into law on Friday, December 18. Buried in this legislation, which is over 2,000 pages long, is a provision that expands your ability to take a penalty-free distribution from your IRA for higher education. We recently discussed 4 mistakes to avoid for attempting to take a penalty-free IRA distribution for higher education expenses, and some of that information has now been changed with this new law.

Qualified Education Expenses
Generally, if you take a taxable distribution from your IRA before you reach age 59 ½, you will be subject to an additional 10% early distribution penalty. However, an exception to the penalty allows you to take a penalty-free distribution from your IRA if you use the funds for qualified higher education expenses. Qualified higher education expenses include tuition, fees, books, and supplies. The expenses must be for education furnished to you, your spouse, or any child or grandchild of you or your spouse.

Computer Expenses Now Included
Prior to the enactment of the PATH Act, the old rules said that if an expense was not required by the school, it was not a qualified education expense. This limitation caused problems in the past for parents who wanted to take a distribution from an IRA and use those funds to pay for a computer for a child attending college. If the computer was not required by the school, it would not be considered a qualified education expense and the distribution would be subject to the 10% early distribution penalty. In one example, a father who bought his daughter a computer so she could avoid late-night walks home from the computer lab was hit with the penalty. He went to court to dispute the application of the penalty and lost his case.

The PATH Act changes the rules for computer technology and related equipment. The definition of higher education expenses is expanded to include expenses for the purchase of computers and related equipment, software, and internet access expenses, if used primarily by a student during any of the years they are in school. This means you can take penalty-free distributions from your IRA to pay for a computer or other computer-related expenses, even if the school your son or daughter attends does not require a computer as a condition of enrollment. Under the PATH Act, this provision is effective for IRA distributions taken in 2015 and later.

Example: Bob’s daughter, Cathy, attends State U, which does not require students to have computers. Cathy would like a computer to use for school work and  personal use. In 2015, Bob may take a penalty-free distribution from his IRA to purchase a new laptop computer, software and internet access for Cathy.

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