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Using a Roth IRA to Pay for Higher Education? Be Careful!

With college costs almost certain to keep increasing each year, parents need to explore every possible tool available to meet the challenge of paying for higher education. Roth IRAs are not just for retirement savings. They can play a vital role in education savings. However, the rules can be tricky. Before you take a distribution from your Roth IRA to pay that tuition bill, be sure you understand the tax consequences.

Contributions and Conversions

If you are thinking of tapping your Roth IRA to pay for college, there is good news if you just withdraw contributions or converted funds. A Roth IRA distribution of tax-year contributions will be tax and penalty-free if used for higher education. Why? Well, your contributions are always available to you tax and penalty free. That part is easy.

Converted funds are a little more complicated. The general rule is that if you are under age 59 ½ you must satisfy a five-year holding period before you can withdraw converted funds without the 10% early distribution penalty applying. However, there is an exception to the penalty when the funds are used for higher education. This means that if you are planning to use converted funds from your Roth IRA to pay for qualified education expenses, those funds will always be available to you tax and penalty free. It does not matter how old you are or how long ago you converted. More good news is that contribution and converted funds are considered the first money to leave your Roth IRA under the Roth IRA ordering rules.

Earnings

Earnings are considered the last funds to leave your Roth IRA under the ordering rules, so a Roth IRA distribution that includes earnings is a little complicated.

To have a qualified Roth IRA distribution of earnings, a five-year holding period must be satisfied, and the distribution must be taken when you are over age 59 ½, disabled, purchasing a first home or deceased. Higher education is not a reason for a qualified Roth IRA distribution. Therefore, if you take a Roth IRA distribution to pay for higher education and you are not 59 ½ or disabled, the portion of your distribution that represents earnings will be taxable. However, no penalty will apply because there is an exception for higher education expenses.

Consider the following example:

Juanita, age 55, has a Roth IRA valued at $20,000. Her Roth IRA consists of $18,000 of converted funds and $2,000 of earnings. She takes a total distribution to pay for her son’s college tuition believing it will be tax and penalty free. She is right that the distribution of converted funds will be tax and penalty free. However, while the earnings portion ($2,000) of the distribution will not subject to penalty, those earnings will be taxable.

I am an Ed Slott Master Elite trained IRA Specialist and I would like to help you. 

If you have any questions regarding this article or would like to schedule a complimentary consultation please call my office at 845-627-8300. My Client Service Coordinator Susan will be happy to set up a convenient time so I can help.

Warm Regards,

Beth Blecker, CEO

Eastern Planning Inc.

Follow Beth Blecker on Twitter: @EasternPlanning

“Ed Slott’s Elite IRA Advisor Group” is solely an indication that the financial advisor has attended training provided by Ed Slott and Company. Ed Slott is not affiliated with Royal Alliance Associates, Inc.  Securities and advisory services offered through Royal Alliance Associates, Inc. Member FINRA/SIPC. Additional advisory and financial planning offered through Affiliated Advisors, Inc. Insurance services offered through Eastern Planning Inc. Listed entities not affiliated with Royal Alliance. Reprinted from The Slott Report, 5/15/2019, with permission.  Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article. Copyright © 2019 Ed Slott and Company, LLC



 


 

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