Paying the Tuition Bill with Retirement Assets

Friday, August 17, 2012

By Beverly DeVeny, IRA Technical Expert

Follow Me on Twitter: @BevIRAEdSlott

A friend of mine, who was paying college tuition for twins, once said to me that you should borrow for college expenses because you cannot borrow to pay retirement expenses. While this is true, the reality is that sometimes we may have to look at funding some of our children’s higher education expenses from whatever assets we can find, including our retirement accounts. There are differences, though, in how distributions from different types of accounts will be treated.

Employer Plans – Distributions of pre-tax funds for higher education will be taxable and also subject to the 10% early distribution penalty if you are under age 59 ½ (there is an exception to the penalty if you separated from service in the year you turned age 55 or later).

IRA Accounts – Distributions of pre-tax funds for higher education will be taxable but will not be subject to the 10% early distribution penalty if they meet certain guidelines. We are currently running a series on the educational expense exception to the 10% penalty. CLICK HERE to read the first 3 of 4 parts.

Roth IRA Accounts – Distributions of contributions and converted amounts will not be subject to income tax. Distributions of pre-tax converted funds for higher education will not be subject to the 10% early distribution penalty if they meet certain guidelines. Distributions of earnings take place once all the contributions and converted amounts are deemed to be distributed. Earnings will be taxable if there has not been a Roth IRA in place for five years and if you are under the age of 59 ½. The 10% early distribution penalty can again be avoided if certain guidelines are met. This procedure runs in accordance with the Roth IRA 5-year rules. CLICK HERE to read some of our other articles on these tricky guidelines.

You can find more information on the guidelines for the early distribution penalty exception for higher education in IRS Publication 590 which is available on the IRS website at www.irs.gov. On the left hand side of the screen, click on Forms and Publications.

 

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