Can You Use IRA for Education?
The increasing costs of education leave many people turning to non-traditional sources to fund their schooling costs, such as individual retirement accounts. If you qualify to take penalty-free withdrawals from your IRA, you can use them for any purpose you desire, including education costs. However, the penalties may be able to be avoided for qualified higher education costs.
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Early Withdrawals
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When you take a non-qualified distribution from your IRA, you may have to pay income taxes and early withdrawal penalties, unless an exception applies. Non-qualified distributions occur when you take money out before age 59 1/2. The IRS does not prevent you from taking early distributions, nor does it require that you specify how you will use the distribution. However, you can avoid the early withdrawal penalty, but not the income taxes, if you use the money for qualified higher education expenses.
Roth IRA Special Treatment
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When you take money out of a Roth IRA, you first withdraw all of the contributions you made to the account. These contributions do not get taxed or subjected to the early withdrawal penalty, no matter how you use them. The IRS only taxes and penalizes your early Roth IRA withdrawals when it consists of earnings. If your withdrawal from a Roth IRA includes earnings, then you must use the early withdrawal penalty exception.
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Qualifying Expenses
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Only qualified higher education costs can avoid the early withdrawal penalty. These expenses include only post-secondary education such as universities, graduate school and trade schools and only include tuition, mandatory fees and, if the student takes at least half the number of credit hours to be considered a full-time student, the expenses for room and board. For example, you exempt your distribution from the early withdrawal penalty if you use the money for college tuition for your son, but not if you use the money for a private elementary school or high school.
Avoiding the Penalty
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When you file your income taxes in a year that you have taken an early IRA distribution, you have to complete Form 5329. Typically, this is to figure the penalty you owe. However, if you used the money for qualified education expenses, you use this form to show why you do not owe the penalty. On line 2, report code "08," the code for higher education expenses, and the amount you spent. Assuming that your higher education expenses equal or exceed the amount of your withdrawal, you will owe no penalties.
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