If you’re paying qualified education expenses, you can withdraw money from an IRA and avoid the usual 10% tax penalty levied on those under age 59½. Problem is, if you withdraw from a retirement account—and that includes taking tax-free withdrawals from a Roth IRA—you’ll increase the income you have to report on your next financial aid application and potentially reduce aid eligibility.
One solution: You might borrow during the early college years and then withdraw from your IRA to repay the loans after your child has submitted his or her final financial aid application. If you’re over age 59½ at that juncture, you won’t have to worry about the tax penalty.
What if you’re under age 59½? If you’re simply withdrawing contributions to a Roth IRA, the tax penalty won’t be an issue. But if you are withdrawing from a traditional IRA or the investment earnings from a Roth IRA, you’ll want to calculate how much in qualified education expenses you have for that year and then withdraw no more than that amount, so you avoid the 10% tax penalty.
Keep in mind that your qualified expenses will be less than the sum of tuition, fees, room and board if part of these costs was covered by other financial assistance, such as a Coverdell withdrawal or a Pell grant.
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