If you want to take money from your IRA before you turn 59.5 years old in order to pay for your child’s college expenses, you may be able to avoid paying the 10 percent penalty that usually applies to early withdrawals. The IRS calls this the “education exception to additional tax on early IRA distributions.”
Although you can do this, there are a few things to consider before making that decision.
You may withdraw funds from your IRA account to pay for qualified education expenses without incurring a penalty, even if you are not yet 59.5 years old. Qualified education expenses include:
- Tuition and fees
- Room and Board
- Education-related supplies and equipment
You will need to claim your education expenses on tax form 1099R. Additionally, the funds must be used on educational expenses in the same tax year in which they were withdrawn from the IRA.
You are allowed to pay the educational expenses for yourself, a spouse, a child, or a grandchild under this provision.
What Are the Income Tax Consequences?
If you have a Roth IRA, there will not be any tax consequences so long as you do not remove more than your initial contribution. For example, if you have contributed $10,000 to your Roth IRA and your account now has $20,000 in it, you can remove that initial $10,000 for college expenses without any tax liabilities.
The situation is different if you have a traditional IRA account. The amount of money that you take from your IRA will be added to your taxable income for the year that you withdraw it. This may end up putting you into a higher tax bracket so you will actually be paying more tax than you would have if you hadn’t taken the cash out.
Will it Affect Your Financial Aid?
One problem with withdrawing money from a Roth IRA to pay for college expenses is that it can potentially affect your financial aid package. Money withdrawn from an IRA must be reported as income on the FAFSA®, although it won’t show up on the application until two years later.
If you are able to wait until the student’s junior year in college, you can withdraw funds from your IRA without it appearing on the FAFSA® at all.
Other College Savings Options
While IRAs are effective as tax-free savings accounts for retirement, they have been surpassed as college saving vehicles. 529 Plans and Coverdell ESAs carry many of the same benefits as IRA accounts, and neither need to be reported on the FAFSA®. It’s important to look through your options before committing to a savings plan.