Englezos: ‘Can I liquidate an IRA to fund a Section 529 Tuition Plan and avoid penalty because it is educational?’

☞ I doubt it, but I don’t know. Let’s ASK LESS!

One rrrrrrring . . .

Two rrrrrrings . . .

‘Hello, Less? I . . .’

‘Say no more – I have Caller ID. Here’s the answer.’

How does he know all this stuff? Anyway, here’s Less’s answer:

The matter isn’t settled in law yet, but it is not something I advise doing, even if there isn’t a penalty, for several reasons:

(1) There will be immediate taxation of all the withdrawn money: it is all ordinary taxation, and only the earnings on the diminished value will be tax-free later on if used for qualified costs.

(2) You must come up with the tax money from other sources, since anything not transferred will DEFINITELY be subject to the 10% federal penalty (and state penalties in most cases).

(3) You are risking your own retirement to finance your child’s college costs. You can virtually always borrow to pay for college, but borrowing to pay for retirement is, for rather obvious reasons, not quite as easy.

On top of all this, there is still the possibility of the penalty on top of the regular taxation, since the IRS has not resolved the matter. The main reason they haven’t resolved it is that, until very recently there would have been no reason whatsoever to try it (since 529 earnings were only tax-deferred, not tax-exempt, until the tax act of 2001, and it was already tax-deferred in the IRA). So somebody will have to be a guinea pig, and I don’t see the point in volunteering.

I suppose if the child is a newborn, there may be enough years of earnings to make the transfer to a 529 plan a potential gainer over time, but I think it would be wiser to simply fund the 529 plan with the money that you were otherwise going to pay in taxes on the transfer this year, letting that compound tax-free while leaving your IRA alone.

By the way, depending on your income, money withdrawn from the IRA in the years of college and used to pay tuition should qualify for the tuition tax credits or deductions, making some of it effectively tax-free anyway, without the transfer.

Thank you, Less.


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