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Cashing in an IRA to pay college costs
Dear Tax Talk:
I withdrew $11,000 dollars from an IRA to pay off a student
loan. I did not claim the money as income, nor did I show it as
an expense. The Internal Revenue Service now has recalculated my
return and says I own additional taxes. That may be correct, but
if it is, can I claim the amount that I paid off (which was $11,000)
to offset some of the new taxes that are due?
Don
Dear Don:
I'm guessing you didn't pay off student
loans that relate to an education in taxes.
You might not have reported the individual retirement
account withdrawal on your tax return, but the IRA custodian reported
to the IRS. This is why the IRS recalculated your tax and is billing
you for additional tax, penalties and interest. You're correct in
not deducting the student loan on your original return, as it was
not then and is not now a tax deduction or offset to the IRA withdrawal.
An early withdrawal (that is, money taken out before
age 59½) from an IRA is subject to a 10-percent penalty in
addition to income tax due on the withdrawal. The payment of qualified
higher education expenses can eliminate the penalty on early IRA
distributions.
Unfortunately, only payments of tuition, books, fees,
supplies and sometimes room and board paid during the year of the
withdrawal are considered higher education expenses. The payment
of a student loan relating to prior years' expenses is not a qualified
higher education expense.
Consider that:
1. The IRA can accumulate tax-free,
2. Student loans tend to have low interest rates,
3. In certain circumstances the interest on the student loan is
deductible and
4. The income tax and penalties due on a withdrawal can be 25
percent to 50 percent of the withdrawal.
It never makes sense to withdraw from an IRA to pay
off a student loan.
-- Posted: June 4, 2002
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