Using An IRA For Education Expenses

When it comes to paying for college or other education expenses, we often have limited options as to where the money should come from. Not only are you trying to find a way to pay the high tuition bill, but how can it be paid while minimizing any penalties, taxes, or negative consequences on your retirement plan?

As we have discussed before, there are multiple ways you can fund your child’s education expenses - including grants, scholarships, college savings plans, tax benefits, and more. One more option is to pay for education expenses from an Individual Retirement Account (IRA).

Using an IRA isn’t typically high on my recommendation list, as I prefer to keep a retirement account invested for retirement, but if all the stars align properly, it can be a viable option. If you need to help your child cover their education expenses and you’d like to use your IRA to do so, here are a few considerations:

Taxes and Penalties

Normally, when taking a distribution from your IRA before you reach age 59 ½, you will be hit with a 10% early withdrawal penalty. However, there is an exception to the rule when it comes to education expenses. You may make a penalty-free withdrawal for qualified higher education expenses.

Qualified higher education expenses include things like tuition, room and board, books, supplies, and more. There is no dollar limit on how much you can withdraw from your IRA for education expenses, so long as you keep records and receipts on the purchases made.

Since an IRA is made up of pre-tax dollars, you will still have to pay income taxes on the amount withdrawn. This is reflected on your tax return and added to your earned income.

Tax Filing

Anytime you make a withdrawal from an IRA, you need to keep good records - especially when claiming an exception to specific rules. When it comes time to file your tax return, you will need to make your tax preparer aware of the education expenses and IRA withdrawal, as the 1099-R you receive from the IRA will not reflect the qualified higher education expenses exception.

Avoid Mistakes

To ensure you don’t get hit with the 10% early withdrawal penalty, there are a few common mistakes you should be aware of.

The withdrawal you make from your IRA must occur in the same calendar year as the expenses were incurred. This can get tricky around the start of the Spring semester, as you may be trying to pay tuition and purchase books/supplies before the new year. If you want to receive the penalty exception, you must make the purchases and IRA withdrawal in the same year.

The 10% early withdrawal penalty exception only applies to IRA withdrawals, not withdrawals from your company retirement plan (401(k), 403(b), etc.). If you make this mistake, you will receive the penalty.

Only make purchases that are required by the school your child is attending. When you are making purchases for your child, be sure to confirm what is required by your school. If the higher education expenses (like certain books or supplies) are not required, then you will not be able to make a penalty-free withdrawal for these.

 

Tell me - how are you paying for your child’s higher education expenses? Keep the conversation going by finding me on Twitter - @rossvmenke

 

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