Individual retirement accounts, as the name suggests, were intended to save for your golden years instead of college costs. As a result, IRAs can only be rolled into another qualified retirement plan, not into a college fund. However, having the money in the IRA isn't the worst place if you need to take a distribution to pay for college expenses.
If you attempt to roll money from your IRA to a college fund, such as a 529 plan, it's treated as a regular distribution from the IRA, which is subject to income taxes. Worse, if you're under 59 1/2, the 10 percent early distribution penalty applies to the taxable portion unless you qualify for an exception, and rolling the money into a college fund doesn't count. For example, if you take $12,000 out of your IRA and put it in a 529 plan, the $12,000 is taxable, and you owe a $1,200 tax penalty on top.
IRA Higher Education Exception
If you need money for college expenses, consider taking a distribution from your IRA. Even though a penalty usually applies to distributions before you turn 59 1/2 years old, there's an exception for distributions used to pay for higher education expenses. Higher education expenses include college tuition, fees, room and board that aren't covered by tax-free scholarships or Pell grants. You can include costs you pay for yourself, your spouse, your children and your grandchildren.
Roth IRA Distributions
When you take withdrawals from a Roth IRA, you always get your contributions back tax-free and penalty-free first. So, no matter how old you are, you can get at least a portion of your money out for college without a big tax bill. For example, say you have $60,000 in contributions in your IRA, and it's worth $100,000. Your first $60,000 in withdrawals aren't taxed or penalized. Anything above that is taxable income, and unless an exception like higher education costs apply, you also owe the 10 percent early withdrawal penalty.
Exception Tax Reporting
If you're using the exception to pay for college expenses, you have a few extra things to report on your taxes. After reporting the distribution as taxable income, you must also complete Form 5329 to document your reason for avoiding the penalty. Next to line 2 in the code space, write "08," the code for higher education expenses. On line 2, write the amount of qualifying expenses you paid during the year. As long as your qualifying expenses equal or exceed your distribution, you won't owe any early withdrawal penalties.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."