This time of year, as high school graduates head off to college, I often am asked by parents, “Can I withdraw from my IRA to help pay college expenses?”
Parents increasingly are sacrificing their own retirement in favor of their children’s education. A recent Boston Globe survey revealed 75% of parents were willing to delay retirement to help pay for their children’s college experience.
The reason is quite understandable since most family’s wealth is held in retirement accounts like IRAs.
The short answer is, “Yes, you can withdraw from your IRA to help pay college expenses.” However, if you are under age 59½ be careful to observe the nine points below to avoid the 10% early distribution penalty.
Which retirement accounts to tap. Penalty-free withdrawals for higher education are only available from your IRA, SEP IRA, and SIMPLE IRAs. If you take the distribution from your company plan such as 401k, 403b, TSP or 457 you will be hit with the 10% penalty.
• Timing rules. The distribution cannot exceed the amount of educational expenses paid in the same calendar year.
• Dollar limits. There are no dollar limits on penalty-free withdrawals. Just remember you will have to declare the withdrawal as income.
• Does the school qualify? Any accredited post-secondary college, university or vocational school qualifies if it is eligible to participate in a student aid program administered by the U.S. Department of Education. This virtually includes all accredited public, nonprofit and proprietary post-secondary institutions.
• Does the student qualify? To be penalty-free, the expense must be for the IRA owner, spouse, children or grandchildren. Siblings, nieces, nephews or cousins do not qualify.
• What are qualifying expenses? Qualifying expenses include tuition, fees, books, supplies, and equipment required by the school. Expenses for computers and related equipment used at the school are penalty-free even if not required by the school. Expenses that are paid for with tax-free educational assistance such as scholarships, Pell grants, Coverdell educational account distributions and veteran’s educational assistance are not eligible for the 10% exception.
• Does room and board qualify? Yes, if the student is considered half-time.
• Will the IRS audit these withdrawals? Yes, it may. It is very important for you to retain good records and documentation of the expenses paid with IRA funds. The burden of proof is on you.
• Is there any special tax reporting? Yes. Your IRA custodian will issue you a Form 1099-R reporting an early distribution, but the 1099-R will not reflect an exception to the 10% penalty. You will need to file Form 5329 to claim the exemption.
When making important decisions like this, it always is wise to seek competent legal, tax and financial advice.
Wm. Steve Wright is a managing member of the Wright Legacy Group.
Wm. Steve Wright is a managing member of the Wright Legacy Group.