It’s back to school time! This means it’s time for school supplies and additional expenses. Are you considering using your IRA to pay that large tuition bill? The rules can be complicated. Here are 10 things you will want to know about using your IRA for educational expenses.
1. Typically, if you take a taxable distribution from your IRA before you reach age 59 ½, you are subject to a 10% early distribution penalty. The exception to the penalty allows you to take a penalty-free distribution from your IRA if you use the funds for qualified higher education expenses.
2. Qualified higher education expenses include tuition, room and board, required fees, books, and supplies. There is no dollar limit for this exception. You can take as much as you want from your IRA to fund your child’s education.
3. Computers and related technology qualify for IRA for educational expenses even if it is not a school requirement.
4. The expenses must be for educational expenses for you, your spouse, or any child or grandchild of you or your spouse.
5. Your IRA distribution and your education expense must happen in the same tax year. Taxpayers have wound up in court over this issue. The Tax Court said to qualify for the exception, the education expense and the IRA distribution must occur in the same year.
6. The exception to the early distribution penalty for higher education applies to distributions from your IRA, not distributions from your company plan.
7. Only post-secondary expenses are qualified higher education expenses. Your child’s high school or grade school tuition or expenses do not qualify.
8. If you qualify for the exception, unless you have basis in your IRA, the distribution will still be taxable to you in the year you take it. You are only escaping the penalty. The income taxes will still be yours to pay.
9. Talk to your tax preparer. Handle claiming the exception on your tax return by filing Form 5498. The Form 1099-R you receive from your IRA custodian will not show that the exception applies to you.
10. Keep good records! While you do not need any specific documentation when you file your taxes, it is a good idea to keep copies of tuition bills and receipts for other expenses with your tax records. That way you will be ready if the IRS should ever question your use of the exception to the penalty.