Roth IRA Education Distributions

What's a Roth IRA education distribution?

That's a good question.

Did you know you can take a penalty-free early withdrawal if you use it to pay for higher education expenses?

That's right. It's one of the many benefits of a Roth IRA.

Even if you're under age 59 ½, you can take an early Roth IRA distribution and avoid part, if not all of, the 10% early withdrawal penalty usually triggered by those in your age group. However, keep in mind that you'll still be on the hook for any income tax liability generated by an early withdrawal.

That said, before you take an early Roth IRA education distribution, make sure that during the tax year...

• You paid qualified higher education expenses
• You paid those expenses to an eligible educational institution, and
• An eligible member of your family incurred the expenses

If you meet each of the above criteria, then you're probably eligible to take an early Roth IRA education distribution and avoid the typical 10% early withdrawal penalty. (Although, keep in mind that this only applies to your Roth IRA investment gains, not your principal contributions. Your Roth IRA principal contributions can be withdrawn tax-free and penalty-free at any time.)

So let's examine each factor individually...

Qualified Higher Education Expenses

What's a "qualified higher education expense"?

According to IRS Publication 590, "qualified higher education expenses" include:

• Tuition
• Fees
• Books
• Supplies, and
• Equipment required for enrollment or attendance

Qualified higher education expenses also include the cost of special needs services related to the enrollment or attendance of a special needs student. In addition, room and board is considered a qualified higher expense for any special needs student who enrolls as at the very least as a half-time student.

Of course, you can only consider these expenses "qualified" if they are related to enrollment or attendance at an eligible educational institution as defined by the IRS. Which, of course, leads us to our next question...

Eligible Educational Institution

What's an "eligible educational institution"?

Good question.

It's always a good idea to know the exact definition of such terms, because your definition and the IRS definition are not always one and the same.

According to IRS Publication 590, an "eligible educational institution" is:

"Any college, university, vocational school, or other postsecondary educational institution eligible to participate in the student aid programs administered by the U.S. Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions."

If you're NOT sure whether your educational institution meets the IRS definition, it's a good idea to ask. The educational institution in question should be able to tell you if it meets the definition of a qualified higher education institution.

Eligible Members of Your Family

Of course, it doesn't matter if you paid qualified higher education expenses at an eligible educational institution if you did so for an ineligible family member...

So who qualifies for this special Roth IRA education distribution exemption?

The following people, and the following people ONLY...

• You
• Your Spouse
• Your Children or Grandchildren
• Your Spouse?s Children or Grandchildren

Nieces and nephews don't qualify. Neither do cousins or best friends. So make sure the person in question qualifies before attempting to take an early Roth IRA education distribution.

Amount Not Subject to the 10% Early Withdrawal Penalty

Assuming you meet the three aforementioned criteria, you're in the clear, right?

That means any amount you withdraw early from your Roth IRA is penalty-free, right?

Not always.

It depends on what type of income or funds you used to pay for the education expenses in the first place. Only certain types of income are eligible for reimbursement via a penalty-free Roth IRA distribution.

According to the IRS , you can use your Roth IRA education distribution to reimburse yourself for qualified higher education expenses already paid using any of the following:

• Payment for services, such as wages
• A loan
• A gift
• An inheritance given to either the student or the individual making the withdrawal
• A withdrawal from personal savings (including savings from a qualified tuition program)

However, if you've used any of the methods below to pay for your education expenses, the 10% early withdrawal penalty is NOT waived if you take an early distribution to reimburse yourself:

• Tax-free distributions from a Coverdell education savings account
• Tax-free part of scholarships and fellowships
• Pell grants
• Employer-provided educational assistance
• Veterans' educational assistance
• Any other tax-free payment (other than a gift or inheritance) received as educational assistance

Does all that make sense?

If not, picture the following scenario...

You're 47 years old with $17,000 in your Roth IRA. Original contributions make up $10,000 of your Roth IRA, while the remaining $7,000 constitutes investment gains. You're in the 25% tax bracket, and you paid $12,000 in out-of-pocket tuition expenses for your 19 year old son who attended the local state university.

In such a case, you're eligible to take an early penalty-free Roth IRA education distribution.

Why?

Because such a distribution meets all the eligibility requirements...

• Tuition is a qualified higher education expense
• The state university is an eligible educational institution
• Your son is an eligible family member, and
• You paid the expenses out-of-pocket (out of your own wages)

In order to reimburse yourself, you take a $12,000 Roth IRA education distribution. The first $10,000 is tax-free and penalty-free...

Why?

Because your original principal contributions to your Roth IRA can be withdrawn at any time, tax-free and penalty-free.

But the remaining $2,000 is made up of investment gains, and investment gains are subject to income taxes. Since you meet the necessary criteria for an early education distribution, and the remaining $2,000 does not exceed your out-of-pocket expenses, you are NOT subject to a 10% early withdrawal penalty.

However, you do owe income taxes.

Since you're in the 25% tax bracket, that comes to $500 in taxes.

So in this case, your $12,000 Roth IRA education distribution results in a reimbursement of $11,500 and a $500 income tax liability.

Conclusion

As a general rule, any Roth IRA withdrawals you make prior to age 59 ½ and prior to meeting the 5 year rule requirement trigger an income tax liability and a 10% early withdrawal penalty.

But an exception is made for Roth IRA education distributions.

While you still owe income taxes on any early withdrawals from your Roth IRA, you can avoid the 10% early withdrawal penalty if the funds withdrawn are equal to or less than the amount of the qualified education expenses you paid for an eligible family member.

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