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Are Withdrawals From an Education IRA Taxable?

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The designated beneficiary of an education IRA can take withdrawals at any time (see When Must Education IRA Assets Be Distributed?, below).  Withdrawals for the designated beneficiary's qualified higher education expenses during the year are generally tax free.

What Determines the Tax Treatment of Withdrawals?

The tax treatment of distributions (withdrawals) from an education IRA depends, in part, on the qualified higher education expenses that a designated beneficiary has in a tax year.

Distribution not more than expenses:

Generally, a withdrawal is tax free if it is not more than the designated beneficiary's qualified higher education expenses in a tax year.

Distribution more than expenses:

Generally, if the total withdrawals for a tax year are more than the qualified higher education expenses, a portion of the amount withdrawn is taxable to the beneficiary.

The taxable portion is the amount that represents earnings that have accumulated tax free in the account.  Figure the taxable amount as shown in the following steps.

1. Multiply the amount withdrawn by a fraction, the numerator (top number) of which is the total contributions in the account and the denominator (bottom number) of which is the total balance in the account before the withdrawal(s). 
2. Subtract the amount figured in (1) from the total amount withdrawn during the year.   This is the amount of earnings included in the withdrawal(s).
3. Multiply the amount of earnings figured in (2) by a fraction, the numerator of which is the qualified higher education expenses paid during the year and the denominator of which is the total amount withdrawn during the year.
4. Subtract the amount figured in (3) from the amount figured in (2).  This is the amount the beneficiary must include in income.

Click Here for an example.

Waiver of tax-free treatment.

The student may waive the tax-free treatment of the education IRA distribution and elect to pay any tax that would otherwise be owed on the distribution.  The student or the student's parents may then be eligible to claim a Hope credit or lifetime learning credit for qualified higher education expenses paid in that tax year.  See IRS Publication 970 for information about these credits.

Additional tax.

Generally, if you receive a taxable distribution, you must pay a 10% additional tax on the amount included in income.

Exceptions.  The 10% additional tax does not apply to distributions that are:

1. Made to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary,
2. Made because the designated beneficiary is disabled,
3. Made because the designated beneficiary received a qualified scholarship excludable from gross income, an educational assistance allowance, or payment for the designated beneficiary's educational expenses that is excludable from gross income under any law of the United States to the extent the distribution is not more than the scholarship, allowance, or payment, or
4. Included in income only because the student waived the tax-free treatment of the withdrawal as discussed earlier.

The 10% additional tax also does not apply to a distribution that is a return of an excess contribution.  For the additional tax not to apply, the distribution must be made before the due date of the contributor's tax return (including extensions) and it must include any net income attributable to that contribution.  That net income also must be included in the contributor's gross income for the tax year the contribution was made.  If the beneficiary does not have to file a return, the excess contribution (and any earnings attributable to it) must be withdrawn by April 15 of the year following the year of the contribution.

           Disabled. You are considered to be disabled if you show proof that you cannot do any substantial gainful activity because of your physical or mental condition.  A physician must determine that your condition can be expected to result in death or to be of long-continued and indefinite duration.

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