5 Things to Know About Using Your IRA for Education Expenses

Saving for both retirement and your child’s college expenses can be a challenge. Tuition, room, board, books, travel and various fees add up fast, and student loans can saddle young people with debt they’ll be paying for decades. Because college costs keep rising, it can be tempting for parents and prospective students to think about turning to retirement funds, such as individual retirement accounts (IRAs), to help pay for college. 

Should you use an IRA to pay for college? If you’re facing hefty tuition bills and have concerns about managing student loan debt, IRA withdrawal for education might be a viable option for you. In general, you can take a taxable distribution — penalty-free — from your IRA before you reach the age 59.5, as long as you use the funds for specific higher education expenses. 

When deciding if IRA education withdrawal is the right choice for you, you’ll want to educate yourself on the facts. Here are some key takeaways:

An IRA distribution for education will not incur a penalty as long as it’s used for qualifying expenses. Here are five rules you need to know if you are considering using an IRA for education expenses.

1. The Distribution Must Be Used for Qualifying Expenses

Typically, IRA withdrawals before age 59.5 result in a 10 percent early distribution penalty, in addition to any regular income tax due. There are two exceptions, however. A down payment on a first home is exempt from the 10 percent early IRA distribution penalty. So are higher education expenses. However, keep in mind that when using an IRA to cover an education expense, you’ll still pay income tax on the portion of the distribution that would otherwise have been subject to income tax.

There are also guidelines for who can use the IRA distribution for higher education. Expenses must be for yourself, your spouse, your child or your grandchild. With these funds, you can pay for books, tuition and other qualifying higher education expenses, as long as the student is enrolled more than half-time at an eligible institution, as defined by the Department of Education.

2. Roth IRAs and Traditional IRAs Follow Different Guidelines

There are two kinds of IRAs. A traditional IRA is funded by money withdrawn from your paycheck before taxes, while a Roth IRA is funded by post-tax dollars. They’re similar in many ways. Both traditional and Roth IRAs allow you to withdraw money for qualified higher education expenses before age 59.5 without incurring the 10 percent early withdrawal penalty.

Furthermore, the amount of your withdrawal from both traditional and Roth IRAs cannot exceed the amount of your qualifying expenses. When money is withdrawn from a traditional IRA account to pay for college-related expenses, the entire amount withdrawn is subject to income tax. Any withdrawal over the amount for qualified higher education expenses is subject to a 10 percent penalty.  

However, a Roth IRA withdrawal functions differently. Withdrawals on the principal on a Roth IRA that you’ve held for at least five years are tax-free if the earnings on that principal aren’t withdrawn. If the account holder is older than 59.5, withdrawal of both earnings and principal are entirely tax-free.

3. You Can Roll a 401(k) Into an IRA to Pay for Education Expenses

If you want to draw on funds in a 401(k) to pay for qualifying higher education expenses, there’s a way to do that. You can take money from your existing 401(k) and roll it over into an IRA, and then use those funds appropriately. However, remember that once you cash in your 401(k), those funds must be deposited into the IRA within 60 days to avoid penalties.

4. An IRA Withdrawal Might Affect Financial Aid

Money in retirement accounts, such as an IRA, is exempt from being evaluated on the Free Application for Federal Student Aid (FAFSA) for financial aid. But if you withdraw IRA funds for educational expenses, they count as income the following year. This impacts the amount reported on the FAFSA, which is used to determine the financial aid your student will receive, so be mindful when withdrawing funds if financial aid is an important part of funding your student’s education. 

5. You Need to File Taxes on Distributions

When you file taxes, you’ll need to fill out a form, usually Form 5329, to report your distribution and note your higher education exception. Make sure you fill out all appropriate paperwork to avoid penalties in the future.

Get Professional Advice on Saving for Education

Education is an important part of securing the future for your student. Talk to a Farm Bureau financial advisor to develop a savings plan that best fits your long-term goals.