There are only a few ways to avoid a 10 percent penalty when withdrawing money from a Roth IRA before age 59 1/2. One of the few methods allowed by the IRS is to use the money for education expenses. However, there are a number of rules you need to follow before closing up your Roth IRA and writing a check to your school with Roth IRA funds.
The IRS only allows withdrawals for tuition, fees, supplies, books and equipment required for attendance or enrollment at an eligible educational institution. As long as the student is enrolled at least half-time, room and board are also considered qualified education expenses. For students living off-campus, the amount withdrawn can't exceed the amount the student would have taken if he'd resided in housing operated by the institution. Qualified institutions include any post-secondary school that is eligible to participate in student aid programs administered by the U.S. Department of Education.
The IRS strictly defines who may withdraw funds for education purposes. You may only make withdrawals when under age 59 1/2 for members of your immediate family. This includes you, your spouse, your child, spouses' child, foster or adopted child, or a descendent of any of the above. Withdrawals for any other individuals will trigger the 10 percent penalty.
Individuals meeting the above guidelines when tapping a Roth IRA for education expenses won't pay a 10 percent penalty, but gains in the account will be taxed as ordinary income if taken prior to the account holder's age 59 1/2. Contributions can be taken tax free first before interest is taken out, but if the account holder dips into gains he must claim these dollars as taxable income.
The financial institution administering your Roth IRA account will send a 1099 detailing the withdrawal of funds. Attach this to your annual tax return by the normal due date. You must fill out Form 5329 and include it with your return. The code exempting you from the 10 percent penalty if you've withdrawn funds for qualified higher education expenses is "08."
Although the IRS charges no fee to close a Roth IRA for education expenses, your IRA account may. Before deciding whether to remove dollars, call your Roth IRA provider and verify all fees. Specifically, there may be fees both to sell the investment and to close the account. Ask about how long it will take to receive funds from the account after closing the Roth IRA. You may have to fill out paperwork and provide a signature to close the account, slowing the process.
- IRS.gov; Publication 970: Tax Benefits for Education; Chapter 9: Education Exception to Additional Tax on Early IRA Distributions
- Bankrate.com; Using Roth IRA to Pay College Expenses; Joseph Hurley, CPA
- Credit Union National Association; Roth IRA Early Withdrawals May Prompt Penalties; Darla Dernovsek
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