Think of Your IRA When Planning For Higher Education Expenses

Careful planning for future education expenses is becoming more common as the national average for college tuition costs continue to rise. Many savers are already familiar with tax-advantaged vehicles such as the 529 Plan or Coverdell Savings Account but did you know that all IRA account structures offer certain incentives for educational expenses as well? This article explores IRS Publication 970 and the exception to additional tax on early IRA distributions for qualified education expenses.

SOURCE: U.S. Department of Education, National Center for Education Statistics. (2013)

When it comes to taking IRA distributions an additional 10% penalty is imposed for withdrawing funds before the designated retirement age of 59 ½. This additional tax applies to the Traditional IRA account structure but also includes SEP IRAs, SIMPLE IRAs, and Roth IRAs. Note that early distribution penalties may be as high as 25% for SIMPLE IRAs.

If you decide to withdraw from an IRA to pay for higher education expenses for either yourself or others, you may be able to avoid the 10% penalty that would normally be imposed. Let’s take a closer look at the eligibility requirements below.

Who is eligible for the exception? 

This exception applies to: yourself as the IRA owner, your spouse, or your or your spouse’s child, foster child, adopted child, or descendant of any of them. 

What is considered an eligible education institution? 

Eligible institutions include: any college, university, vocational school, or other postsecondary school eligible to participate in a student aid program administrated by the U.S. Department of Education. 

What types of expenses are considered ‘qualified’ education expenses (QEE)?

• Tuition
• Fees
• Books
• Supplies
• Equipment required for enrollment or attendance.
• Services for special needs students in connection with their enrollment or attendance. 
• Room and board if the student is enrolled at least half-time. Half-time status is determined under the standards provided by each individual institution.
• See Publication 970 for specific details on room and board.

Be sure to review IRS Publication 970 for additional details, considerations, and examples. The information provided in this article is for educational purposes only and is not guaranteed to be reliable. Always see a qualified tax professional who can offer advice and guidance. New Direction IRA does not offer tax, legal, or investment advice.

2014 IRA Contribution and Distribution Rules

People in the accumulation phase of their working lives are often concerned about “maxing” out individual retirement account (IRA) contributions while retirees are concerned about annual required minimum distributions (RMD). Whether contributing or withdrawing, the amounts change almost annually due to inflation protections and life expectancy tables. Below is a discussion on 2014 traditional IRA rules.

2014 IRA Contribution Considerations

A traditional IRA is a fantastic retirement tool that allows tax deductions for those contributing and tax-deferred growth on investments. IRA rules also allow those investors nearing retirement age (50 years and older) to contribute more to their IRA plans than someone younger. If you are engaged in 2014 retirement planning, below are the IRA contribution limits for 2014:

• $5,500 for those below age 50
• $6,500 for those above age 50
• Anyone age 70 ½ + cannot contribute to a traditional IRA 

In order to contribute to an individual retirement plan, one must earn a taxable income. In other words, in order to contribute $5,500, for example, a person must have made at least $5,500 in taxable income.

2014 IRA Distribution Considerations

If you are a retired traditional IRA investor over age 70 ½ or you have inherited a traditional IRA, you are probably considering your 2014 required minimum distribution (RMD) amount. While investment growth of a traditional IRA is tax-deferred, withdrawals are considered ordinary income. A required minimum distribution is calculated based on the total IRA account balance and your life expectancy or the life expectancy of who you inherited it from. Please keep in mind a few other IRA withdrawal considerations outside of retirement and inheritance:

• As a broad rule, taking a distribution from a traditional IRA account before age 59 ½ will result in a 10% IRS penalty. Consult your tax expert for more specifics on penalty exclusions. 
• ROTH IRA accounts do not have required minimum distributions.
• The penalty for missing your 2014 RMD is 50% of the difference between what should have been distributed and what actually was. 
• There is no penalty for withdrawing more than your required minimum distribution. 

While it may feel like 2014 is almost over, IRA contributions can be made until April 15^th 2015. This allows anyone planning for retirement to consult with his or her tax advisor to choose the most tax-advantaged amount of contribution or withdrawal based on concrete 2014 taxable income calculations.