IRA Withdrawal for Education: 5 Key Things to Know

Parents know the dilemma well: how can you balance both retirement savings while also covering college expenses? 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, parents and prospective students may be tempted to turn to retirement funds, such as individual retirement accounts (IRAs), to help pay for college. 

But is IRA withdrawal for education a good idea? Generally, the rule of thumb is that there are loans available for your child’s education; there are no loans available for retirement. However, for some people using an IRA to pay for education might be a viable option. 

How much you can withdraw from an IRA for education is guided by a set of factors and tax guidelines. An IRA distribution for education will not incur a penalty as long as it’s used for qualifying expenses. In general, you can take a taxable distribution — penalty-free — from your IRA before you reach the age 59 1/2, as long as you use the funds for qualified higher education expenses. 

That doesn’t mean you should make the decision blindly. When deciding if IRA education withdrawal is the right choice for you, you’ll want to explore all the rules and implications. Here are five education IRA withdrawal rules you need to know if you are considering using an IRA to pay for college.

1. Can I Use My IRA to Pay for College? Roth vs. Traditional Rules

Before deciding to withdraw money from an IRA, you need to know what kind of IRA you have. Both traditional and Roth IRAs allow you to withdraw money for qualified higher education expenses before age 59 1/2 without incurring the 10 percent early withdrawal penalty. Both follow the same rule that the amount that you withdraw cannot exceed the amount of your qualifying expenses. The difference is your tax liability.

• Traditional IRA: Funded with pre-tax dollars, meaning withdrawals for qualified higher education expenses will be subject to ordinary income.
• Roth IRA: Funded with post-tax dollars, allowing you to withdraw contributions tax-free. However, if you have had a Roth IRA for less than five years and withdraw more than you have contributed, the amount over what you’ve contributed (your earnings) are taxable. 

1. Education IRA Withdrawal Rules: What Expenses Qualify?

Typically, IRA withdrawals before reaching age 59 ½ result in a 10 percent early withdrawal penalty, in addition to any regular income tax due. So, in general, withdrawing from an IRA early is inadvisable. 

There are exceptions to the early withdrawal penalty, including qualified higher education expenses. Remember, you’ll still be taxed on IRA withdrawal for education; the portion of the distribution that would otherwise have been subject to income tax will still be taxed. But you won’t have to pay an additional penalty, which may make this a good option for your family’s needs.

Here's another factor to consider: there are also guidelines for who can use the IRA distribution for higher education. To use an IRA to pay for college expenses, it must be for yourself, your spouse, your child or your grandchild. With these funds, you can withdraw money without the early withdrawal penalty to 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.

1. How to Use a 401(k) Rollover for Education Expenses

Maybe you’re thinking about withdrawing money on another kind of retirement savings — a 401(k), which is different from an IRA — to pay for qualified higher education expenses. You   may be able to access your money early with a hardship distribution, but the 10 percent early withdrawal penalty applies if you’re not 59½, and there are other financial implications set to deter people from accessing 401(k) funds for anything except retirement. 

If this is the route you want to take, you can roll your 401(k) into an IRA, and then use those funds appropriately. However, remember that once you cash in your 401(k), you must complete the rollover within 60 days to avoid penalties. 

1. How IRA Withdrawals Impact Financial Aid Eligibility

Funds that are in retirement accounts, such as an IRA, are exempt from being evaluated on the Free Application for Federal Student Aid (FAFSA) for financial aid. But if you withdraw money from an IRA for college expenses, the amount will be counted as taxable income the following year. This change can impact financial aid eligibility, which is used to determine the financial aid your student will receive. So, think about future years of education expenses, and be mindful when withdrawing funds if financial aid is an important part of funding your student’s education. 

1. How Much Can You Withdraw From an IRA for Education? Tax Filing Rules

When you file your tax return, you’ll need to report your IRA withdrawals for education to avoid extra penalties. Typically, you must fill out a 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. 

Plan Your Child’s College Fund

Education is an important part of securing the future for your student. Talk to a Farm Bureau agent or financial advisor to help you explore tax-advantaged strategies to pay for college while protecting your retirement savings.