What are Qualified Education Expenses for IRA Withdrawal?

If you are struggling to pay education expenses you may be allowed to tap into your IRA before you attain retirement age. The IRS allows retirement savers to use the IRA retirement savings to pay qualified college expenses for yourself, spouse, son/daughter, or grandchildren without owing IRS penalties. However, not all college expenses qualify for the penalty exemption.

Qualified education expenses for IRA withdrawal are the amounts paid for tuition, books, education-related supplies and equipment, as well as room and board. To be eligible, the student must be enrolled in a post-secondary institution such as a vocational institution, college, or university. You will be exempted from paying an early withdrawal penalty if you use the IRA withdrawal to pay for qualified education expenses.

Rules for Using IRA Money to Pay for College Expenses

The IRS provides certain rules that retirement savers must follow when using their IRA funds to pay for college expenses.

Usually, if you withdraw money from an IRA before age 59 ½, this withdrawal will be considered an early withdrawal, and you could pay a 10% penalty. However, you may be exempted from paying this penalty if you are using the funds to pay for qualified education expenses. 

The IRS also requires that students must be enrolled or scheduled to enroll in a qualifying institution. The student must be in a post-secondary institution such as a vocational school, for-profit or non-profit college, or university. The student must also be eligible to participate in a government-administered student aid program.

Qualifying Education Expenses

Qualifying education expenses are the expenses that qualify for exemption from the 10% early withdrawal penalty. Some of the qualified education expenses may include tuition, cost of books, supplies, equipment, disability services, as well as room and board (if the student is enrolled at least more than half-time).

You can take a distribution from your IRA to offset qualified education expenses that were paid for using wages, savings, and loans. However, you can only offset expenses incurred in the current year. Also, you cannot use IRA funds to offset qualified education expenses paid for using grants and scholarships.

Also, you can only withdraw from your IRA an amount equal to the qualifying education expenses you are paying. If the amount withdrawn from your IRA exceeds the qualifying education expenses, you will pay a 10% penalty on the excess withdrawal.

Education Expenses that do not qualify

Some education expenses are not exempted from the early withdrawal penalty, and this means you will incur the 10% penalty for these expenses. Some of these expenses include medical expenses, transportation, personal living expenses, insurance, and room and board (if the student is enrolled less than half the time). Also, expenses incurred in sports and games do not qualify for the penalty exemption unless the sport is part of the student's education program.

Penalty exemption requirement

The IRS imposes a 10% penalty on taxable withdrawals made before age 59 ½ from IRAs. However, the IRS offers exemptions to this penalty to people with major expenses in life. For example, you may be exempted from paying this penalty if you are a first-time homebuyer, paying unreimbursed medical expenses, and using the funds to pay for college. If you are withdrawing funds from a traditional IRA, you will still pay ordinary income taxes on the distribution.

To qualify for the penalty exemption for education expenses, you must have qualifying college expenses in the year when you take a distribution. If you plan to join college in the next year, you will owe a 10% penalty if you withdraw money from your IRA in the current year.

Also, you must prove that the student is enrolled in an eligible higher learning institution. The institution must be an accredited private or public post-secondary institution, and the institution must be eligible for student aid programs that are available through the US Department of Education. It is not enough to just provide the name of your institution; you must verify that your institution is eligible for the student aid programs.

Does IRA Withdrawal Affect Financial AID

The amount you withdraw from your IRA to pay for college will affect your financial aid disbursement. Students are required to report any amounts withdrawn from an IRA as income on the FAFSA, which most institutions use to determine financial aid awards.

Since FAFSA uses tax information from two years ago, the funds drawn from an IRA will affect your aid awards two years after the withdrawal. If you don’t want the IRA funds to appear on FAFSA, you can withdraw and use the retirement funds during junior and senior levels when the funds will no longer be considered on FAFSA in determining eligibility for student aid.

Using Roth IRA to Pay for College

If you have a Roth IRA, you will contribute after-tax dollars to the account, and the funds will grow tax-free over the years. Since you paid taxes on contributions, you won’t pay tax when you take a qualified distribution in retirement. For a distribution to be considered qualified, you must be above age 59 ½ and held the Roth IRA account for at least five years.  

You can withdraw your contributions to pay qualified education expenses at any time without paying taxes and penalties. However, if you withdraw earnings from your Roth IRA and you are below age 59 ½, you will pay taxes and penalties on the distribution.