Your IRA is supposed to fund your retirement, but when you've got college expenses piling up -- for you or for your child -- it's tempting to want to dip into those savings. Typically, an early withdrawal from an IRA would incur a 10 percent penalty charge in addition to any taxes owed. However, certain college expenses are exempt from this penalty.
Qualified Educational Expenses
In order to qualify for the penalty exemption, you must use the money to pay for qualified educational expenses. The school you attend must be accredited by the Department of Education. Tuition and fees, books, supplies and other program costs are all included in qualified expenses. If you are attending at least half time, you can also use the money for room and board.
You may have to pay taxes on the money that you use for college expenses, even though you won't incur an early-withdrawal penalty. If you have a traditional IRA, you will have to pay taxes on the full amount that you withdraw. If you completely cash out a Roth IRA, you will have to pay taxes on the earnings. However, if you withdraw less than the amount that you've contributed to the Roth IRA, you will not have to pay taxes.
The Income Trap
Any money that you withdraw will count as income for that tax year. Though you may not have to pay taxes on this amount, it will count as income. When the school reviews your financial information for financial-aid purposes, this additional income could cause you to lose some of the federal, state and school financial aid that you were receiving.
The main purpose of an IRA account is to set aside money for your retirement. This money grows tax-free until you retire. When you withdraw the money for college, you no longer have the potential to earn interest. Though you may later be able to replace the money with your future income, you lose the years that it could be earning money. If possible, the smartest move is to take full advantage of any financial aid that you can get from the government or the school before you dip into your IRA.
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