IRA Distributions to Pay for Education
Generally, any withdrawal of money from an IRA account — be it a traditional IRA, Roth IRA, or SIMPLE IRA — before the age of 59½ is subject to an additional tax. For a traditional IRA or Roth IRA, the additional tax is 10%; for a SIMPLE IRA, 25% for the 1st 2 years; 10%, thereafter. However, if the distributions are used to pay for qualified educational expenses, then the additional tax can be avoided. Regular income taxes will be due however, on distributions from a traditional or SIMPLE IRA, but not from a Roth IRA, since the contributions were tax-deductible when made. If the amount of the distribution is greater than the adjusted qualified educational expenses, then that portion will be subject to the applicable tax penalty.
Eligibility. The IRA owner can pay for the educational expenses for himself, his spouse, or his child, foster child, adopted child, or any descendant of either the account owner or the spouse.
Qualified educational expenses include: tuition, fees, books, supplies, and equipment that are required either for enrolling or attending an eligible educational institution. Qualified educational expenses also include special needs services for special needs students.
Room and board will also qualify if the student is taking at least half of the full course load and the expense does not exceed the greater of the following:
- the actual amount charged for housing owned or operated by the eligible educational institution; or
- the amount included in the cost of attendance as determined for federal financial aid purposes for a given living arrangement and for a particular academic period.
The taxpayer can find out about the qualified room and board costs from the institution.
An eligible educational institution is any postsecondary educational institution — such as a college, university, or vocational school — that is eligible to participate in the student aid program administered by the United States Department of Education.
The adjusted qualified education expenses (AQEE) must be calculated to determine how much tax must be paid. Tax law does not allow a specific expense to be used to claim more than one deduction or credit nor can any deduction be claimed on tax-free income. Therefore, all such expenses that were used either to claim a deduction or an educational tax credits, such as the American Opportunity credit and the Lifetime Learning credit, or income that was received tax-free must be subtracted from the total of paid qualified educational expenses. Tax-free income includes the tax-free portion of scholarships and fellowships and Pell grants, veterans' educational assistance, and expenses that were used as the basis for figuring either tax-free distributions from a Coverdell Education Savings Account (ESA) or educational tax credits.
However, there is no subtraction for gifts or inheritance, loans, payment for services, such as wages, or withdrawals from personal savings, including qualified tuition program accounts.
If the IRA distribution does not exceed the AQEE, then none of the distribution will be subject to the 10% additional tax; otherwise:
10% Tax Penalty = (IRA Distribution – AQEE) × 10%
If the contributions to the IRA account were tax-deductible, such as they are for traditional IRAs and SIMPLE IRAs, then the entire distribution must be included in the income of the taxpayer, but the 10% tax penalty will only apply to that portion of the distribution that exceeds AQEE.
|Distribution from Roth IRA|
|Payment for Qualified Educational Expenses||$10,000|
|Expenses Used to Calculate Lifetime Learning Credit||$3,000|
|Employer-Provided Educational Assistance||$5,000|
|Early Distribution from Roth IRA||$4,000|
|Taxable Earnings from Roth IRA Distribution||$600|
|Tax-Free Educational Assistance||$8,000||= Total of Other Expenses Used for Taxable Deductions or Credits|
|Adjusted Qualified Education Expenses (AQEE)||$2,000||= Total Paid Qualified Education Expenses – Tax-Free Educational Assistance|
|Distribution from Traditional IRA|
|Same Facts as Above Except:|
|Early Distribution from Traditional IRA||$4,000|
|Amount Subject to 10% Penalty||$2,000||= Traditional IRA Distribution – AQEE|
|10% Penalty Tax||$200||= Amount Subject to Penalty × 10%|
|Taxable Amount Includable in Income||$4,000|
Reporting IRA Distributions
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Early distributions from IRA accounts must be reported. Generally, the IRA custodian will send the taxpayer a Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, Etc., which will show how much of the distribution must be included in gross income and subject to income taxes and how much of the distribution would ordinarily be subject to the additional tax. The taxpayer will have to figure the amount that will actually be subject to the additional tax, by completing Part I and Part II of Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.