A simplified employee pension IRA provides tax-deferred savings for businesses and self-employed people. Contributions to this type of individual retirement account are tax deductible and count as ordinary income when you take money out. You risk a 10 percent additional tax if you remove money from a SEP-IRA before age 59 1/2. However, the Internal Revenue Service doesn't penalize certain early withdrawals, including ones for qualified education expenses.
SEP-IRAs have higher contribution limits than traditional IRAs. As of the 2013 tax year, you can contribute 25 percent of compensation or $51,000, whichever is less. The contribution limit for a traditional or Roth IRA is $5,500, or $6,500 if you are age 50 or older. If you are self-employed, the IRS may limit the deduction you can take on your SEP contribution. Use the worksheets and tables for the self-employed in Chapter 5 of IRA Publication 560 to figure your deduction.
You and your spouse can avoid penalties on SEP money you siphon for qualified education expenses. The expenses can apply to you, your spouse, your children or your children's kids. Eligible education institutions include virtually all accredited postsecondary schools, whether public, nonprofit or private. Any school that can participate in a U.S. Department of Education student aid program is automatically eligible. Foreign schools that participate in a Federal Student Aid program also qualify.
You can avoid penalties on SEP-IRA money you use to pay for tuition, books, supplies, fees and equipment needed to enroll or attend an eligible school. You can also avoid penalties for any expenses stemming from a student's special needs. The IRS doesn't penalize SEP money you fork over to pay room and board for half- or full-time students. The room and board costs can't be greater than the sum of any cost allowance the school sets for attendance and the actual amount charged by the college if it owns or operates the student housing.
Calculating the Exemption
You can only avoid penalties on school-related SEP withdrawals you make in the same year you incur the qualified education expense. You must subtract tax-free educational assistance you receive from your educational expense before figuring your exemption. This assistance includes the tax-free portion from sources like a Coverdell education savings account, scholarships, Pell grants, veterans' education assistance and employer-provided assistance. Your remaining qualified expenses escape the IRS penalty.
Your SEP-IRA custodian will send copies of Form 1099-R to you and the IRS in the January following the year you take out the money. This form identifies the withdrawn amount and a distribution code indicating you took the cash to pay for education. You use this information to file Form 5329, in which you show how much of your distribution is penalty-free. If your SEP contains any nondeductible contributions, you must also file Form 8606, because part of your distribution may be tax-free. Include your results on Form 1040 or 1040NR according to IRS instructions.
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