7. Early Withdrawals From IRAs

Important Changes for 2002

Qualified education expenses expanded.   The definition of qualified higher education expenses has been expanded to include certain expenses for special needs students.

Allowed expenses for room and board changed.   The limit on the amount that is considered reasonable for room and board expenses has been changed. You must contact the educational institution for its qualified room and board costs. For more information, see Qualified higher education expenses.

Introduction

Generally, if you make withdrawals from your IRA before you reach age 59½, you must pay a 10% additional tax on the early withdrawal. This applies to any IRA you own, whether it is a traditional IRA (including a SEP-IRA), a Roth IRA, or a SIMPLE IRA. Publication 590, Individual Retirement Arrangements (IRAs), has more information about these IRAs.

However, you can make withdrawals from your IRAs for qualified higher education expenses without having to pay the 10% additional tax. You will owe income tax on at least part of the amount withdrawn, but you will not have to pay the 10% additional tax on early withdrawals.

The part not subject to the additional tax is generally the amount that is not more than the adjusted qualified higher education expenses for the year.

Who Can Make Early Withdrawals Free of the 10% Tax?

You can make a withdrawal from your IRA before you reach age 59½ and not have to pay the 10% additional tax if, for the year of the withdrawal, you pay qualified higher education expenses for yourself, your spouse, or you or your spouse's children or grandchildren.

Qualified higher education expenses.   These expenses are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. Beginning in 2002, they also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance.

As of this printing, regulations defining a special needs beneficiary have not been released. If available, the definition will be included in Publication 553, Highlights of 2002 Tax Changes, which will be issued in early 2003.

In addition, if the student is at least a half-time student, room and board are qualified higher education expenses.

The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts.

1. The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.
2. The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

Eligible educational institution.   An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

Half-time student.   A student is enrolled at least half-time if he or she is enrolled for at least half the full-time academic work load for the course of study the student is pursuing as determined under the standards of the school where the student is enrolled.

How Do You Figure the Amount Not Subject to the 10% Tax?

When determining the amount of the withdrawal that is not subject to the 10% additional tax, first find your adjusted qualified higher education expenses. You do this by reducing your total qualified expenses by any expenses paid with the following funds.

1. Tax-free withdrawals from a Coverdell ESA (formerly known as an education IRA).
2. Tax-free scholarships.
3. Tax-free employer-provided educational assistance.
4. Any tax-free payment (other than a gift, bequest, or devise) due to enrollment at an eligible educational institution.

Do not reduce the total by any expenses paid with the following funds.

1. An individual's earnings.
2. A loan.
3. A gift.
4. An inheritance given to either the student or the individual making the withdrawal.
5. Personal savings (including savings from a qualified tuition program).

After determining the adjusted amount of qualified higher education expenses, compare that amount to the amount of the IRA withdrawal to determine how much, if any, of the withdrawal is subject to the 10% additional tax.

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