Can I Use IRA Money to Pay Tuition?
Congress created individual retirement accounts (IRAs) as a way for people to save for retirement. IRAs have evolved, however, into more diverse investments thanks to laws that relax the tax penalty on certain types of early withdrawals, including those used to pay for qualified higher education expenses.
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Function
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An IRA provides key tax benefits, thus its attraction as a long-term investment. If you own a traditional IRA, the IRS allows you to deduct your contributions, up to an annual limit, from your taxable income. When you access traditional IRA money, the IRS taxes it as your regular income tax rate. As IRS Publication 590 illustrates, while Roth IRA contributions are not tax-deductible, the IRS does not tax your contributions when you withdraw them from a Roth.
General Process
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In most cases, if you withdraw money from a traditional or Roth IRA prior to turning age 59 1/2, the IRS not only charges applicable taxes on the distribution, it also levies an additional 10 percent tax penalty. You must also have held a Roth IRA for a minimum of five tax years or else the IRS subjects your withdrawals, even after age 59 1/2, to the 10 percent tax. Paying for tuition as well as other associated higher education expenses with IRA money provides one exception to these general rules.
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Features
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As noted, you can use IRA funds, without incurring the 10 percent penalty, to pay for higher education costs, including tuition. If you use your traditional IRA to do this, the IRS still taxes the money you take out at your regular income tax rate. With a Roth, any original contributions you tap come out tax free. However, the IRS taxes accumulated earnings that you access. As Publication 590 explains, the IRS allows you to exhaust original Roth contributions before taking out your taxable earnings. The IRS also waives the Roth IRA five-year rule for early withdrawals used to cover higher education expenses.
Considerations
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The IRS allows you to use IRA money to fund "qualified higher education expenses," according to Publication 590. These "qualified" costs include "tuition, fees, books, supplies and equipment required" for at least half-time attendance at colleges, universities, vocational schools and other post-secondary educational institutions that can take part in aid programs offered by the U.S. Department of Education.
You can exercise this exception to the 10 percent tax penalty rule on early withdrawals to satisfy your own higher education expenses or those of your spouse, children or grandchildren.
Process
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When you take a distribution from an IRA, your IRA custodian -- the firm that you opened your account with or transferred your account to -- sends you and the IRS a 1099-R form. This form details all withdrawals you took from IRAs during the tax year. If you indicate to your custodian that you are using the money to fund higher education expenses, it will make the proper notations on the 1099-R that show you are taking a qualified early distribution that is exempt from the 10 percent tax penalty. All you need to do is file your taxes, report the distributions and what you paid for college expenses and save your receipts in case the IRS has any questions down the road.
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