A Syllabus on Penalty-Free IRA Withdrawals for Higher Education Expenses
By Ian Berger, JD
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It’s that time of the year! College bills for the Fall semester are arriving, and you may be thinking of tapping into your retirement savings to help with the costs. If you’re under age 59 ½, be careful. Your withdrawal may be subject to a 10% early distribution penalty unless you are able to take advantage of an exception to that penalty. (Remember that, even if you qualify for the exception to the penalty, distributions from traditional IRAs will be taxable.) Here’s what you need to know about the higher education expense exception:
1. Take it from your IRA. Penalty-free withdrawals for higher education are only available from your IRA (including SEP and SIMPLE IRAs). If you take an early distribution from your company plan, you’ll be hit with the 10% penalty.
2. Watch the timing. There are no dollar limits on penalty-free withdrawals; however, the distribution can’t exceed the amount of education expenses paid in the same calendar year.
3. Make sure the school qualifies. Any accredited post-secondary (post-high school) educational institution – including a foreign institution – qualifies as long as it is eligible to participate in a student aid program administered by the U.S. Department of Education.
4. Make sure the student qualifies. To be penalty-free, the expense must be for education of the IRA owner or his spouse, or for any child or grandchild of either. Siblings, nieces, nephews and cousins don’t qualify.
5. Make sure the expense qualifies. Qualifying expenses include tuition, fees, books, supplies and equipment required by the school. Expenses for computers and related equipment used at school are penalty-free – even if not required by the school. Note that a person must be considered at least a half-time student in order for room and board to qualify. Finally, expenses paid for with tax-free educational assistance (i.e., with scholarships, Pell grants, Coverdell education account distributions and veterans' educational assistance) are not eligible for the 10% exception.
6. Keep good records. It is important for you to retain good documentation of the expenses you paid for with the IRA funds. In case of an IRS audit, the burden is on you to prove the distribution was for a qualified education expense.
7. File 5329. Your IRA custodian will issue a Form 1099-R showing an early distribution, but the 1099-R will not reflect an exception to the 10% penalty. It will be up to you to file Form 5329 to claim the exemption.
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