Some employers use a simplified employee pension individual retirement account instead of a 401(k) for their employees' retirement savings. Knowing the education withdrawal rule will come in handy if you're building your SEP just to pay your kid's college bills. If you're still in school, knowing those rules might be your best argument to convince mom and dad that tapping their SEP IRA won't bury them with penalties.
Unlike other employer-sponsored plans like 401(k)s and 403(b)s, SEP IRA money is available whenever you want and for any expense. Your employer also can't slap conditions on the account, such as saying you have to leave the money there for a certain period of time. However, if you're under 59 1/2, you'll pay an extra tax penalty of 10 percent (25 percent if the SEP IRA is less than 24 months old) unless an exception applies.
Education Penalty Exception
You can always avoid the penalty if the withdrawal is for qualified educational expenses for an eligible student. The student has to attend a school of higher learning that accepts United States Department of Education loan programs. That will be hard not to do since that describes virtually every college in the land. The penalty exception equals your qualified expenses.
Most college costs, including tuition, fees, textbooks and other necessary supplies, count as qualified expenses. You can even count room and board in that haul if the child is enrolled at least half-time. Those costs are limited to the larger of the amount listed in the college's cost of attendance or the actual costs if the kid lives on campus. However, if the kid gets Pell grants and scholarships, you have to reduce any qualified expenses by the amount of that tax-free assistance. Say your kid had $25,000 in expenses and a $5,000 Pell grant: You can exempt $20,000 of distributions from the early withdrawal penalty.
The exception doesn't get you out of paying income taxes if you take the withdrawal before you turn 59 1/2. Your financial institution sends you a Form 1099-R that shows the distribution as a nonqualified withdrawal. To avoid the penalty, fill out Form 5329 and use the code "08" next to line 2 to show you paid higher education expenses. You don't get the penalty as long as you didn't take out more than your kid's qualified college expenses.