Should You Use Your IRA to Pay for School?

Generally, it’s not a good idea to tap into your retirement fund. In most cases you’ll have to pay a 10% fee and repay the amount. However, the IRS says there are two situations when tapping into your IRA is okay, at least by them. You can use funds from your IRA when purchasing a home or paying for higher education without paying the 10% penalty. But, like anytime you mess with your nest egg you need to consider all the rules and consequences.

Now here are the rules when you use funds to pay for education:

1. You can use IRA funds to pay for schooling costs for yourself, your spouse or your children or grandchildren.

2. The school can be a college, university, vocational school or other postsecondary facility that meets federal student aid program requirements. If they require a FAFSA for financial aid, they are part of the federal student aid program.

3. The school can be public, private or nonprofit as long as it is accredited.

4. You can use retirement money to pay tuition and fees and buy books, supplies and other required equipment.

5. Retirement funds may also be used to cover expenses for special-needs students.

6. Funds may be used for housing expenses if the student is enrolled at least half time.

HOWEVER: You may owe income tax on at least part of the amount withdrawn from your IRA, but you may not have to pay the 10% additional tax.

Generally, if the taxable part of the distribution is less than or equal to the adjusted qualified education expenses (AQEE), none of the distribution is subject to the additional tax. If the taxable part of the distribution is more than the AQEE, only the excess is subject to the additional tax.

Got it? Yeah, not so simple, eh?

Figuring the Amount Not Subject to the 10% Tax

To figure if you will need to pay, first determine your AQEE. You do this by finding the difference between your total qualified education expenses and any tax-free educational assistance, which includes:

  • Expenses used to figure the tax-free portion of distributions from a Coverdell education savings account (ESA),
  • The tax-free part of scholarships and fellowships,
  • Pell grants,
  • Veterans’ educational assistance,
  • Employer-provided educational assistance, and
  • Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.

Funds not included are wages, loans, gifts, inheritance, or personal savings.

If your IRA distribution is equal to or less than your AQEE, you will not pay the 10% additional tax.

Before you use IRA funds to pay for education, you may want to consult your tax advisor and/or financial advisor to determine if the withdrawal works for your situation.

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