|
|
Individual Retirement Accounts are very popular instruments for retirement financial planning. And sometimes, an IRA may be also a useful financial tool for necessities other than retirement funding.
|
|
Earlier this summer, we dedicated one of our newsletters to early withdrawals from retirement accounts, so you know by now how early distributions can affect your taxes.
|
|
|
|
And you know that generally, if you take a distribution from your IRA before you reach age 59½, you must pay a 10% additional tax on the early distribution. This applies to any IRA you own, whether it is a traditional IRA (including a SEP-IRA), a Roth IRA, or a SIMPLE IRA. The additional tax on an early distribution from a SIMPLE IRA may be as high as 25%.
|
|
|
However, you can take distributions from your IRAs for qualified higher education expenses without having to pay the 10% additional tax. You may owe income tax on at least part of the amount distributed, but you may not have to pay the 10% additional tax.
|
|
Generally, if the taxable part of the distribution is less than or equal to the adjusted qualified education expenses (AQEE), none of the distribution is subject to the additional tax. If the taxable part of the distribution is more than the AQEE, only the excess is subject to the additional tax.
|
|
|
|
You can take a distribution from your IRA before you reach age 59½ and not have to pay the 10% additional tax if, for the year of the distribution, you pay qualified education expenses for:
|
|
|
|
|
|
|
|
|
|
|
- Your or your spouse's child, foster child, adopted child, or descendant of any of them.
|
|
|
For purposes of the 10% additional tax, the qualified education expenses are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.
|
|
| They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance. |
|
|
| In addition, if the student is at least a half-time student, room and board are qualified education expenses. A student is enrolled “at least half-time” if he or she is enrolled for at least half the full-time academic work load for the course of study the student is pursuing as determined under the standards of the school where the student is enrolled. |
|
| The expense for room and board qualifies only to the extent that it isn't more than the greater of the following two amounts: |
|
- The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student;
|
|
- The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.
|
|
| You may need to contact the eligible educational institution for qualified room and board costs. |
|
| An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution. |
|
|
|
|
|
|
|
|
| Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs. |
|
| To determine the amount of your distribution that isn't subject to the 10% additional tax, first you must figure your adjusted qualified education expenses. You do this by reducing your total qualified education expenses by any tax-free educational assistance, which includes: |
|
- Expenses used to figure the tax-free portion of distributions from a Coverdell education savings account (ESA);
|
|
- The tax-free part of scholarships and fellowship grants;
|
|
- The tax-free part of Pell grants;
|
|
- Veterans’ educational assistance;
|
|
- Employer-provided educational assistance; and
|
|
- Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.
|
|
Don't reduce the qualified education expenses by amounts paid with funds the student receives as:
|
|
- Payment for services, such as wages;
|
|
|
|
|
|
|
|
- An inheritance given to either the student or the individual making the withdrawal; or
|
|
- A withdrawal from personal savings (including savings from a qualified tuition program).
|
|
| If your IRA distribution is equal to or less than your adjusted qualified education expenses, you aren't subject to the 10% additional tax. |
|
| By the end of January of the following year, the payer of your IRA distribution should send you Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The information on this form will help you determine how much of your distribution is taxable for income tax purposes and how much is subject to the 10% additional tax. |
|
| If you received an early distribution from your IRA, you must report the taxable part of the distribution on Form 1040, line 15b (Form 1040NR, line 16b). |
|
Then, if you qualify for an exception for qualified higher education expenses, you must file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, to show how much, if any, of your early distribution is subject to the 10% additional tax.
|
|
| Of course, your best option, as always, is to seek advice from a professional in all your dealings with the IRS, as well as for all your important financial decisions. |
|
|
|
|
|
|
|
|
|
