Whether you're paying for yourself to go back to school or for your kids to go to an elite private school, you might be tempted to raid your individual retirement arrangement to pay for it. However, not all private school costs qualify for the education exemption, so you might find yourself paying a large tax penalty if you're not careful.
Roth IRA Treatment
Roth IRAs offer slightly different tax treatment of early distributions than traditional IRAs. First, Roth IRAs have two requirements for qualified withdrawals. First, that you are at least 59 1/2 years old or permanently disabled. Second, that the account be five years old. Traditional IRAs only require that you be 59 1/2 years old.
Because you make only after-tax contributions to a Roth, you get to remove all of your contributions tax-free any time you want. As a result, if you want, you could remove your contributions tax-free and penalty-free to pay for private school tuition of any level for your kids. However, once you've removed all of your contributions, the tax treatment for earnings withdrawn early from a Roth IRA is the same as for distributions from a traditional IRA. (ref 2, p. 62-64)
Post-Secondary Schools Only
The early IRA withdrawal exception only applies to qualified expenses at post-secondary schools like colleges, universities and trade schools. To qualify, the school has to be eligible to participate in student aid programs offered by the U.S. Department of Education. However, these programs as available to private schools, including for-profit schools, as well as public and government-run schools, according to Internal Revenue Service Publication 970. However, if you're attempting to take an early IRA distribution to pay for private school preschool, elementary or high school for your kids, you won't qualify. (ref 1, p. 59)
For the exception to apply, you've got to pay qualifying expenses at the private school. These always include tuition, fees, supplies and books. If you enroll at least part time, you can include your room and board costs, too. However, you're limited to the larger of the amount listed by the school for room and board in its cost of attendance or the amount you paid if you live in on-campus housing. In addition, you have to reduce your qualifying expenses by any tax-free aid you receive. For example, if you have $9,000 in qualifying expenses and a $5,000 scholarship, your early withdrawal exception only applies to $4,000. (ref 1, p. 59)
Only Exempts from Penalty
The exemption for higher education expenses only exempts your IRA distribution from the 10 percent additional tax penalty, not from the taxes on the distribution, even if you use it for expenses at a post-secondary private school. For example, say you fall in the 15 percent tax bracket and you take a $10,000 taxable early distribution to pay for your master's degree at an eligible private school. You'll still owe $1,500 in income taxes but you'll avoid the $1,000 early withdrawal penalty. (ref 2, p. 49)
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."