Evans Wealth Management Blog

Articles written by Evans Wealth Management are designed to educate clients & potential clients on concepts important to their financial future.

A Warning When Using IRA Funds to Pay for College

It is that time of year when we celebrate our graduates and turn our attention to paying for college. According to the National Center for Education Statistics (NCES), the average cost of one year of college can be over $39,000. It is no wonder many parents turn to their IRAs to help fund it.

Originally, IRAs were established to encourage saving for retirement. Rules were developed to tax and penalize those withdrawing funds prior to 59.5 years of age. However, exceptions were allowed in certain instances enabling you to avoid the penalty. One such exception is paying qualified higher education expenses.

The IRS nor the Tax Court has had any problem with the use of IRA funds paying qualified expenses. However, they both have taken issue with what taxpayers have provided as proof the funds were used for qualified higher education expenses.

Tax Court Memo 2018-202 reminds us of the importance of keeping documented proof the funds were used in a manner qualifying for the exception. In this case, the taxpayers supplied email that were judged by the court as appearing inauthentic and other documents failed to prove the distributed amounts were used to pay for qualified higher education expenses. It caused the amounts to be subject to the 10% early withdrawal penalty.

The takeaway from this example is receipts for all eligible expenses should be kept in the event you are audited. Additionally, Form 5329 must be filed to claim the exception.

It should also be noted the taxpayers in this example prepared their own tax returns via tax preparation software and represented themselves in Tax Court. They walked out of court with a $65,235 federal income tax deficiency and an accuracy-related penalty of $12,378. Maybe, professional tax preparation is much more cost-effective than they thought.

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