Back to School? 10 Things You Must Know About Using Your IRA For Educational Expenses

The arrival of August means that it’s back to school time! This means it is time for new school supplies and other bigger expenses. Are you thinking about using your IRA to pay that large tuition bill? The rules can be complicated. Here are 10 things you will want to know:

1. Usually, 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.

2. Qualified higher education expenses can include tuition, room and board, required fees, books, and supplies. There is no dollar limit for this exception. You can take as much as you want from your IRA to fund your child’s education.

3. Computers and related technology are also a qualified educational expense even if it is not specifically required by the school.

4. The expenses must be for education furnished to you, your spouse, or any child or grandchild of you or your spouse.

5. Make sure your IRA distribution and your education expense happen in the same tax year. Some taxpayers have wound up in court over this issue. The Tax Court said to qualify for the exception, the education expense and the IRA distribution must occur in the same year.

6. The exception to the early distribution penalty for higher education only applies to distributions from your IRA, not distributions from your company plan.

7. Only post-secondary expenses are considered to be qualified higher education expenses. Your child’s high school or grade school tuition or expenses will not qualify.

8. Don’t forget that even if you qualify for the exception, unless you have basis in your IRA, the distribution will still be fully taxable to you in the year you take it. You are only escaping the penalty. The income taxes will still be yours to pay.

9. Talk to your tax preparer. You will need to handle claiming the exception on your tax return by filing Form 5498. The Form 1099-R you receive from your IRA custodian will not show that the exception applies to you.

10. Keep good records! While you do not need any specific documentation when you file your taxes, it is a good idea to keep copies of tuition bills and receipts for other expenses with your tax records. That way you will be ready if the IRS should ever question your use of the exception to the penalty.

By Sarah Brenner, JD, IRA Analyst

Gregory Ricks & Associates is a Registered Investment Advisor.  We are an independent firm helping individuals create retirement strategies using a variety of insurance and investment products to custom suit their needs and objectives. This material is intended to provide general information to help you understand basic financial planning strategies and should not be construed as financial advice. All investments are subject to risk, including the complete loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.

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