What is an IRA? -- A Brief Review
A traditional IRA is a self-directed savings account you set up with a custodian -- often your stockbroker -- that offers specific federal tax advantages. The IRS lets you put a certain amount of earnings into your IRA account each year without paying income taxes on those earnings until you withdraw them at age 59 1/2 or older. For example, a married couple, both aged 30, earning $50,000 in 2014, can contribute a total of $11,000 to one or more IRA accounts and can contribute similar amounts in each following year until withdrawal. This allows them to defer taxes for decades on both capital contributions and subsequent earnings.
Early Withdrawal Penalties and Exceptions
People who withdraw money from a traditional IRA before age 59 1/2 usually must pay both the income taxes due and an additional 10 percent penalty on the amount withdrawn. The IRS makes a few exceptions for certain medical expenses and for first-time home buyers. Another important exception is for qualified educational expenses, which are discussed in detail in IRS Publication 970, Tax Benefits for Education.
What Is a Qualified Educational Expense?
Qualified educational expenses are tuition, books, fees, supplies and "equipment required for enrollment or attendance at an eligible educational institution." With some limitations -- detailed in IRS Publication 970 -- room and board for students who attend at least half-time may also be eligible.
A qualified educational institution is "any college, university, vocational school or other postsecondary educational institution eligible to participate" in the program administered by the U. S. Department of Education. Although the IRS recommends asking the institution where you intend to enroll if it is qualified, there have been occasional problems with some for-profit institutions making false claims of eligibility. A better route is to consult the Department of Education's database of eligible institutions.
Payment and Reporting Requirements
If you withdraw money from your IRA, be sure to spend that money on qualified educational expenses within 120 days of the withdrawal date. Otherwise, the withdrawal may be subject to the 10 percent penalty.
The custodian of your IRA account will send you an IRS Form 1009-R, where you will report your distribution and determine its tax and/or exemption status. Taxable earnings from the distribution must be reported on your Form 1040 at line 15b. You must also file a form 5329 to show how much of your early distribution is taxable or exempt. You can get additional help with this from IRS Instructions for Form 5329, Part 1 or from your tax advisor.