Pixy and other experts,

A question has arisen on another board on whether Roth IRA earnings would be taxed if used to pay for college. The confusion started because of a story on NBC news.

Someone asked TMFTaxes, who replied:

>>>>>Yes, there will certainly be tax associated with the distribution.

Since the distribution is make prior to age 59 1/2, it will be treated as a non-qualifed distribution....subject to tax.

I would love to have heard the NBC report to see what they were really driving at. But there are no provisions that I can find that would exempt the earnings from tax.<<<<

I replied that I *still* think it is a qualified distribution if it used to pay for college or your first home.

Here's another way to look at it: Under the new tax laws, either a Roth or a "regular" IRA can now be tapped to pay for college or first homes, right? Now, the regular IRA earnings will be taxed upon withdrawal, whether paying for college or taken after 59 1/2. So, no extra penalty either way. Therefore it doesn't make sense to me that Roth earnings would be taxed to pay for college, but not after 59 1/2. That's adding an extra penalty for tapping a Roth for college, but no extra penalty for tapping a regular IRA.

Pixy, what say ye?

Regards,

orangeblood

<<... Now, the regular IRA earnings will be taxed upon withdrawal, whether paying for college or taken after 59 1/2. So, no extra penalty either way. Therefore it doesn't make sense to me that Roth earnings would be taxed to pay for college, but not after 59 1/2. That's adding an extra penalty for tapping a Roth for college, but no extra penalty for tapping a regular IRA.>>

This looks like a "gift" with a big string attached.
1) No penalty. Great. But you still have to pay 28% (marginal) income tax, plus state income tax of around 3%-7%. This come to around one-third that you lose to taxes. After they take a gallon of blood, they don't take an extra pint. BFD

2) After you take the money out of the IRA, you can't put it back in.

You might well be better off not tapping into your IRA, and coming up with the house/tuition money from some other source.

Ray

Orangeblood,

<<A question has arisen on another board on whether Roth IRA earnings would be taxed if used to pay for college. The confusion started because of a story on NBC news.

Someone asked TMFTaxes, who replied:

>>>>>Yes, there will certainly be tax associated with the distribution.

Since the distribution is make prior to age 59 1/2, it will be treated as a non-qualifed distribution....subject to tax.

I would love to have heard the NBC report to see what they were really driving at. But there are no provisions that I can find that would exempt the earnings from tax.<<<<

I replied that I *still* think it is a qualified distribution if it used to pay for college or your first home.

Here's another way to look at it: Under the new tax laws, either a Roth or a "regular" IRA can now be tapped to pay for college or first homes, right? Now, the regular IRA earnings will be taxed upon withdrawal, whether paying for college or taken after 59 1/2. So, no extra penalty either way. Therefore it doesn't make sense to me that Roth earnings would be taxed to pay for college, but not after 59 1/2. That's adding an extra penalty for tapping a Roth for college, but no extra penalty for tapping a regular IRA.

Pixy, what say ye?>>

I say that the law defines a "qualified" Roth distribution as one made from EARNINGS that occurs after the account has been open for five tax-years and which meets at least one of the following conditions: The owner is over age 59 ½; the owner is disabled; the owner has died; or to finance a first-time home purchase.

Two comments here are necessary. First, contributions are considered the first money out (subject to the five-year wait on conversion money), and may be taken tax-free at any time. Therefore, withdrawal of contributions isn't an issue, but withdrawal of earnings is. Second, education expenses are not defined as a qualified distribution in Roth law. If taken from contributions, no tax applies anyway. But if taken from earnings (i.e., all contributions have been previously withdrawn), then the withdrawal WILL be taxed. The penalty will be avoided if under age 59 ½ because of the nature of the withdrawal, but as in a traditional IRA the withdrawal will be taxed.

Regards……Pixy

Ray,

<<You might well be better off not tapping into your IRA, and coming up with the house/tuition money from some other source.>>

Particularly when one remembers this is a RETIREMENT and not a savings account. However, I see the rationale. Folks are reluctant to "save" for retirement if they see no opportunity to retrieve those savings for special expenses. The knowledge they can may encourage more to use those vehicles. With luck, most will see the loss they will suffer by removing those funds early. I doubt it, though.

Regards…..Pxiy

Pixy,

>>>>If taken from contributions, no tax applies anyway. But if taken from earnings (i.e., all contributions have been previously withdrawn), then the withdrawal WILL be taxed. The penalty will be avoided if under age 59 ½ because of the nature of the withdrawal, but as in a traditional IRA the withdrawal will be taxed.<<<<<

Therefore, if one decides to use some IRA money to pay for a child's college education in 10 years (if earnings are to be tapped), then the best course of action would be to use a traditional IRA.... correct?

Thanks,

orangeblood

>>><<You might well be better off not tapping into your IRA, and coming up with the house/tuition money from some other source.>>

>>Particularly when one remembers this is a RETIREMENT and not a savings account.<<<<

Maybe before, but not now. With the new rules, I am beginning to look more and more at the Roth as a type of savings account (I would only be using money not earmarked for retirement). The ability to withdraw the contributions without penalty... on top of letting the earnings grow tax free... very tempting.


Regards,

orangeblood

Orangeblood,

<<Therefore, if one decides to use some IRA money to pay for a child's college education in 10 years (if earnings are to be tapped), then the best course of action would be to use a traditional IRA.... correct?>>

IMHO, yes. Take it from a Roth and you'll lose the compounding on something that ultimately won't be taxed. Take it from a traditional IRA instead because that will be taxed anyway.

Regards…..Pixy

Orangeblood.

<<Maybe before, but not now. With the new rules, I am beginning to look more and more at the Roth as a type of savings account (I would only be using money not earmarked for retirement). The ability to withdraw the contributions without penalty... on top of letting the earnings grow tax free... very tempting.>>

I'm afraid you are right, and many will think this way. Sad that because it is NOT why the vehicle was established and will help contribute to its early demise IMHO.

Regards….Pixy

>> I'm afraid you are right, and many will think this way. Sad that because it is NOT why the vehicle was established and will help contribute to its early demise IMHO.
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Nonetheless, I think that the options for no-penalty withdrawal serve a useful function (which may nor may not have been intentional).

By this I mean that the fear of needing the money for an emergency can be a barrier to retirement investing. Knowing that it's possible to withdraw at least the amount contributed may help to surmount that barrier.

TchrP,

<<Nonetheless, I think that the options for no-penalty withdrawal serve a useful function (which may nor may not have been intentional).

By this I mean that the fear of needing the money for an emergency can be a barrier to retirement investing. Knowing that it's possible to withdraw at least the amount contributed may help to surmount that barrier.>>

I totally agree. My fear is too many will just view the vehicle as a piggy bank that can be raided at will. If so, our "parents" in Congress will kill it in a flash.

Regards…..Pixy