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IRA Withdrawals for Qualified Higher Education Expenses

How do UTMA accounts stand up versus 529 plans?

Susan T. Bart, 07/31/2009

College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to advisorquest@morningstar.com.

Withdrawals from an individual retirement account made while the IRA owner is under the age of 59½ years generally are subject to a 10% penalty tax in addition to the income tax ordinarily imposed on IRA distributions. There are, however, some exceptions to the imposition of the penalty tax on early withdrawals.

One exception is for "substantially equal periodic payments" for the life or life expectancy of the participant or the joint lives or joint life expectancies of the participant and the designated beneficiary. Internal Revenue Code § 72(t)(2)(A)(iv). This exception, however, will not apply if the periodic payments are subsequently modified within five years or before the participant attains age 59½. Internal Revenue Code § 72(t)(4).

Another exception is for distributions that are used to pay qualified higher education expenses. Internal Revenue Code § 72(t)(2)(E).

(E) DISTRIBUTIONS FROM INDIVIDUAL RETIREMENT PLANS FOR HIGHER EDUCATION EXPENSES. - Distributions to an individual from an individual retirement plan to the extent such distributions do not exceed the qualified higher education expenses (as defined in paragraph (7)) of the taxpayer for the taxable year. Distributions shall not be taken into account under the preceding sentence if such distributions are described in subparagraph (A), (C), or (D) or to the extent paragraph (1) does not apply to such distributions by reason of subparagraph (B).

In a recent Tax Court case, the IRA participant, who was under age 59½, began taking substantially equal periodic payments from her IRA. Two years later, while still under age 59½, she withdrew from her IRA her annual substantially equal periodic payment plus additional amounts to pay her son's college expenses. The IRS argued that she had "modified" the substantially equal periodic payments and imposed the ten percent penalty tax.

The Tax Court ruled against the IRS, reasoning that the two different exceptions could be applied independently and that taking substantially equal periodic payments should not preclude the taxpayer from taking advantage of the exception for withdrawals used to pay qualified higher education expenses.

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