If you're concerned about the cost of your children's educations, it might come as a relief to learn that you can tap into your individual retirement account to fund education expenses -- penalty free -- even if you're not age 59 1/2. However, before you withdraw from your IRA, make sure your children's education expenses qualify for penalty-free withdrawals.
You only avoid the early withdrawal penalty for expenses incurred at an eligible educational institution. These are schools that are eligible to participate in student financial assistance programs through the U.S. Department of Education, which includes most colleges, universities and trade schools. Elementary and high schools are not considered qualified expenses, so if you take out money to pay for those costs for your child, the 10 percent early withdrawal penalty still applies.
The IRS doesn't allow you to write a blank check to a child to use at his own discretion. You retirement funds can only go toward tuition, fees, supplies and equipment. If your child is enrolled at least half-time, you can also count room and board costs. However, your child's room and board can't exceed the allowance for room and board, as determined by the school and included in the cost of attendance for federal financial aid purposes -- and if your child lives in school housing, you can't allow for more than the amount actually charged.
If your withdrawing from a traditional IRA, even if the education expenses qualify, you only avoid the 10 percent early withdrawal penalty -- not the income tax due on the distribution. With a traditional IRA, your contributions are tax-free, so you have to pay up when you withdraw -- even if the withdrawal is going toward your child's education. However, if you're withdrawing from a Roth IRA, you get to remove your contributions tax-free and penalty-free first. However, after withdrawing the amount of your contributions, you then have to pay taxes on any earnings you withdraw.
To avoid the early withdrawal penalty, when you file your taxes, you have to file Form 5329. Next to line 2, write "08," which is the code for higher education expenses. On line 2, write the amount of qualified expenses for your child for the year. As long as the amount of qualified expenses is equal to or greater than your distribution, your entire distribution for your child's education avoids the early withdrawal penalty.
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