An individual retirement account (IRA) is a good place to set aside funds for your retirement years, because the funds in your IRA account are allowed to grow tax deferred until you withdraw them. Since an IRA is a retirement account, there are certain incentives and penalties that are designed to encourage you to leave the funds in your IRA until you reach retirement age. The penalties may be waived if you take an early withdrawal to fund your college education.
There are two primary types of IRAs: traditional IRAs and Roth IRAs. Both types of IRA accounts allow the earnings inside the account to grow tax deferred. You can typically take a tax deduction for contributions to a traditional IRA, but contributions to a Roth IRA must be made with after tax dollars. All withdrawals from a traditional IRA are taxed as ordinary income. Withdrawals of the contribution portion of a Roth IRA are not subject to taxation, since taxes have already been paid on these funds. Qualified withdrawals of the earnings portion of a Roth IRA are not subject to federal income taxes, but non-qualified withdrawals are taxed as ordinary income.
Any funds you withdraw from a traditional IRA prior to you reaching 59 1/2 years of age are subject to ordinary income taxes plus a 10 percent tax penalty. The earnings portion of your Roth IRA must remain in the account for at least five years. Withdrawals of the earnings prior to five years are taxed as ordinary income and are subject to a 10 percent tax penalty, regardless of your age. Withdrawals that are made before you reach age 59 1/2 are subject to ordinary income taxes plus a 10 percent penalty, regardless of how long the earnings have been in your Roth account. The 10 percent tax penalty may be waived if you used the withdrawn amount to pay for qualifying education expenses.
Qualifying Educational Expenses
There is no way to avoid paying ordinary income taxes on non-qualified withdrawals from either a traditional or Roth IRA. You can avoid paying the 10 percent tax penalty if you use the withdrawals to pay for qualifying expenses for post-secondary education, Qualifying expenses include all costs associated with enrollment or attendance at an eligible educational institution such as tuition, books, supplies, fees and equipment. You can also include certain costs for room and board.
You can use your withdrawal to pay higher education expenses for yourself, your spouse, your children, your step-children, your adopted children, your foster children or any of their descendants. You can use your withdrawals to pay any institution of higher learning such as a college, university, technical institute, vocational school or other post-secondary educational institution that is eligible to participate in a U.S. Department of Education-administered student aid program.
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