Do you need extra cash to pay for your child's (or your own) college tuition? When you've exhausted other conventional sources, you can turn to your IRA in a pinch, even if you're younger than the age generally required for penalty-free distributions.
Strategy: Withdraw the funds with the law in mind. In particular, make sure you pay tuition expenses in the same year in which you take the distribution. If you don't, you won't qualify for the tax-law exception for early withdrawals.
Here's the story: Generally, withdrawals from an IRA or a qualified retirement plan account are subject to a 10 percent penalty tax—in addition to regular income tax—if you make them prior to age 591/2. But the tax code lists several specific exceptions to this rule. Example: IRA withdrawals made before age 591/2 are exempt from the penalty tax if you use the money to pay for qualified education expenses.
But timing is everything.
Case in point: A woman wanted to use her retirement fund money to pay for college. So, she paid most of the tuition expenses by credit card in the years prior to her graduation in 2001. During 2001, she withdrew $20,000 from her IRA and used that money to pay the credit-card debt attributable to her college expenses in 1999 and 2000.
But the Tax Court said that only the amount paid for qualified tuition expenses incurred during 2001 were exempt from the 10 percent tax. In other words, amounts charged to her credit card in prior years aren't eligible for the tax break.
Reason: Withdrawals must be taken for the taxable year in which you incur education expenses. Since the credit card charges were for expenses in prior years, the 2001 withdrawal to pay off those charges did not qualify. (Lodder-Beckert, TC Memo 2005-162)
Tip: The same interpretation would probably apply to other exceptions to the early withdrawal penalty. Example: Distributions used to pay for qualified medical expenses or first-time home-buyer expenses would be exempt from the penalty only if they're made in the same tax year as the expenses.
- Small Business Tax Deduction Strategies No matches