Higher education expenses can be steep. Fortunately for those under the age of 59 ½ who need to dip into retirement savings to cover these costs, there is an exception to the 10% early withdrawal penalty. Before tapping your IRA, be sure to understand the fundamentals of this penalty exception. Here are the basics:

 

  • The 10% penalty exception applies to IRAs only. It does not apply to workplace retirement plans like a 401(k) or 403(b).
  • The exception only allows the IRA owner to avoid the early distribution penalty. Any pre-tax distributions taken will still be taxed as usual.
  • There is no dollar limit for qualified higher education expenses.
  • Qualified education expenses must be incurred in connection with a student’s enrollment in an “eligible educational institution.” If there is a question about eligibility, the educational institution should be able to tell you if it qualifies.
  • The institution does not need to be located within U.S. borders.
  • The 10% higher education penalty exception is not available to cover costs associated with primary or secondary school, e.g., high school.
  • The higher education costs must be for the IRA account owner or his spouse, child, or grandchild of either the owner or spouse. Nephews, cousins and siblings do not qualify.
  • “Qualified higher education expenses” are tuition, fees, books, supplies and equipment required for the enrollment or attendance of a student at an eligible educational institution. This also includes expenses for special-needs services incurred by or for special-needs students in connection with their enrollment or attendance.
  • A person must be considered at least a half-time student for room and board to qualify as higher education expenses.
  • Computer or other computer-related expenses qualify, even if the school does not require a computer as a condition of enrollment.
  • IRA distributions must be made in the same calendar year that the bill is paid.
  • The IRA custodian will issue Form 1099-R showing an early distribution. There will be nothing on this form to indicate that an exception to the 10% early distribution penalty applies. It is up to the taxpayer to properly claim the exception on their tax return.
  • There is no age limit on who can qualify for the qualified higher education IRA penalty exception.

Facts of the Qualified Higher Education IRA Penalty Exception

Higher education expenses can be steep. Fortunately for those under the age of 59 ½ who need to dip into retirement savings to cover these costs, there is an exception to the 10% early withdrawal penalty. Before tapping your IRA, be sure to understand the fundamentals of this penalty exception.