Dear Tax Talk,
My wife has a Roth IRA, and we want to use it to help pay for our daughter’s college tuition. I understand from reading the response to another question that the principal can be taken out without penalty. Is the principal amount also called the basis? Does using the money for a child’s tuition meet the requirement of using it for education, or does it have to be for the education of the owner of the Roth? Lastly, if we take all the money out, principal and earnings, what are the consequences?
When taking a distribution, you have to determine what type of distribution you are receiving. Once you know that information, you can then figure out if it can be included in your income and if you are subject to the additional 10 percent tax on early distributions.
So, let’s start with the different types of Roth IRA distributions. The first one is qualified distributions. These are not included in your gross income and additionally are not subject to the 10 percent additional tax on early distributions. According to the IRS, a qualified distribution must be made after the five-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit. Other qualified distributions are those made on or after you reach the age of 59 1/2, distributions due to disability, payments made to a beneficiary or your estate after your death, or up to $10,000 of a distribution toward the purchase of a home if you meet the requirements for a first-time homebuyer.
You must pay the 10 percent additional tax on the taxable part of any distribution that is not a qualified distribution unless you meet one of the exceptions listed in IRS Publication 590 Individual Retirement Accounts. For nonqualified distributions, only the earnings are subject to tax. Your own contributions to a Roth IRA can be taken out anytime, tax-free.
An exception for education applies to payments made to qualified higher education expenses paid to eligible educational institutions for not only you and your spouse, but also your children and your grandchildren. So yes, that would apply to your daughter.
Your wife’s basis in her Roth IRA is the amount of after-tax dollars that has been contributed to the account — in other words, her contribution.
I hope this information is useful to you. On a final note, do not forget to take a look at IRS Publication 970 Tax Benefits for Education, as you may qualify for various credits or tax deductions if your daughter is your dependent.
Ask the adviser
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.