Using Your IRA to Pay for College and Higher Education
Many investors use their self-directed IRA to fund their retirement by investing in what they know and love. But some investors may also use funds from their self-directed IRA to pay for a college education—either for themselves, a spouse, or a child or grandchild.
While IRAs are generally considered a terrific tool for saving for retirement, many investors are not aware that IRA distributions used to pay for higher education expenses may be exempt from the 10% early distribution penalty when the IRA owner is under 59 ½.
The educational expenses must be incurred at an eligible educational institution (see below) and there are several factors that determine if the distribution is exempt, so before making a move, I encourage investors to discuss their situation with the tax and financial advisor. Until then, here’s some helpful information about using funds from your IRA to pay for higher educational expenses:
Making IRA withdrawals to pay for higher education
In general, if you make a withdrawal from your traditional IRA before the age of 59½, you must pay a 10% penalty tax on the amount of the withdrawal. However, withdrawals used to pay for qualified higher education expenses may not be subject to the 10% penalty tax—although all or part of the amount withdrawn may still be subject to income tax. You are also allowed to withdraw the exact amount of your contributions from a Roth IRA at any time without having to pay a tax or penalty.
Where applicable, the IRS education exception simply allows you to avoid paying the additional 10% tax on an early IRA distribution. Also, it's important to know that colleges treat IRA distributions as income when calculating financial aid packages. If you use IRA withdrawals to pay for your child's college, it may impact the amount of financial aid you or your child will be eligible to receive. It’s best to consult with the financial aid office or your tax advisor to determine how it may apply in your particular situation.
Who is eligible to use IRA withdrawals to pay for college?
In general, you can make a withdrawal from your IRA before you reach age 59½ and not have to pay the 10% additional tax if the funds will be used to pay qualified education expenses for:
o Your spouse
o Your or your spouse's child, foster child, adopted child or descendent of any of them (e.g., grandchild).
What qualifies as an eligible educational institution?
The IRS considers an eligible educational institution to be any college, university, vocational school, or other postsecondary educational institution that is eligible to participate in a student aid program administered by the U.S. Department of Education.
What qualifies as eligible higher education expenses?
Qualified higher education expenses include tuition, fees, books and supplies. It can also include room and board if the student is enrolled in an eligible educational institution at least half time.
Tax reporting for your IRA education withdrawal
You will need to report your IRA distribution at tax time. If you received an early distribution from your IRA, the IRS requires you to report the taxable amount of the distribution on Form 1040 or Form 1040NR. If you qualify for an exception for qualified higher education expenses, you must file Form 5329 to show how much, if any, of the early distribution is subject to the 10% additional tax.
Again, prior to making a withdrawal from your IRA for education, I recommend you consult with a tax professional.
At PENSCO we make it possible to invest in real estate, private equity and notes with a self-directed IRA. If you are interested in learning more about how IRAs work and alternative investments, download our free IRA Investors Guide.
This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.
Pacific Premier Trust (formerly PENSCO Trust Company) performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Pacific Premier Trust is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.