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What are the Rules for Penalty-Free Higher Education Expense Withdrawals? Thumbnail

What are the Rules for Penalty-Free Higher Education Expense Withdrawals?

If you’re facing the unpleasant prospect of paying college bills for the fall semester, you may be thinking of tapping into your retirement savings to help with the costs. If you’re under age 59 ½, there is an exception to the 10% early distribution penalty for higher education expenses. But there are several rules you need to follow: 

There are several rules to follow when thinking of tapping into your retirement savings, which includes: Not taking it from your company plan, making sure the student and school qualify, and filing a Form 5329 as some examples.

  • Don’t take it from your company plan. Penalty-free withdrawals for higher education are only available from your IRA (including SEP and SIMPLE IRAs). If you take an early distribution from your company plan, you’ll be hit with the 10% penalty.
  • Watch the timing. There are no dollar limits on penalty-free withdrawals. But the distribution can’t exceed the amount of education expenses you pay in the same calendar year.
  • Make sure the student qualifies. The expense must be for education of the IRA owner or his spouse, or for any child or grandchild of either. What about siblings, nieces, nephews and cousins? Sorry, they don’t qualify.
  • Make sure the school qualifies. Any accredited post-secondary (post-high school) educational institution – including a foreign institution – qualifies as long as it’s eligible to participate in a student aid program administered by the U.S. Department of Education.
  • Make sure the expense qualifies. Qualifying expenses include tuition, fees, books, supplies and equipment required by the school. A person must be considered at least a half-time student in order for room and board to qualify. Expenses for computers and related equipment used at school also qualify – even if not required by the school. However, expenses paid for with tax-free educational assistance (e.g., with scholarships, Pell grants or Coverdell education account distributions) aren’t eligible.
  • Keep good records.  Retain good documentation of the expenses you paid for with the IRA funds. In case of an IRS audit, the burden is on you to prove the distribution was for a qualified education expense.
  • File 5329. The IRA custodian will issue you a Form 1099-R showing an early distribution, but it won’t reflect an exception to the 10% penalty. It’s up to you to file Form 5329 with your federal tax return to claim the exemption.
  • Use non-retirement funds first. Even if you qualify for the penalty exception, distributions from traditional IRAs are taxable. Also, withdrawals cause you to lose out on tax-deferred (or tax-free) growth in your IRA. So, if you have other non-retirement funds, you may want to tap into those first.

By Ian Berger, JD
IRA Analyst
Ed Slott and Company, LLC

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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.

Copyright © 2023, Ed Slott and Company, LLC Reprinted from The Slott Report, 08/07/23, with permission. https://www.irahelp.com/slottreport/what-are-rules-penalty-free-higher-education-expense-withdrawals, Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article. 
Investment advisory services offered through Mutual Advisors, LLC DBA California Retirement Advisors, a SEC registered investment adviser. Securities offered through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities, Inc. and Mutual Advisors, LLC are affiliated companies. CA Insurance license #0B09076. This content is developed from sources believed to be providing accurate information and provided by California Retirement Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. California Retirement Advisors, nor any of its members, are tax accountants or legal attorneys and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional.