Image alt tag

Error!

There was a problem contacting the server. Please try after sometime.

Sorry, we are unable to process your request.

Error!

We're sorry, but the Insights and Intelligence Tool is temporarily unavailable

If this problem persists, or if you need immediate assistance, please contact Customer Service at 1-888-522-2388.

Error!

We're sorry, but the Literature Center checkout function is temporarily unavailable.

If this problem persists, or if you need immediate assistance, please contact Customer Service at 1-888-522-2388.

Tracked Funds

You have 0 funds on your mutual fund watch list.

Begin by selecting funds to create a personalized watch list.

(as of 12/05/2015)

Pending Orders

You have 0 items in your cart.

Subscribe and order forms, fact sheets, presentations, and other documents that can help advisers grow their business.

Reset Your Password

Financial Professionals*

Your password must be a minimum of characters.

Confirmation Message

Your LordAbbett.com password was successully updated. This page will be refreshed after 3 seconds.

OK

 

Retirement Perspectives

Investors are allowed to tap a retirement account to pay for higher education expenses without a tax penalty.

It’s the most wonderful time of the year for parents now that their kids are back in the classroom. However, parents that must pay for college education may not be so thrilled. Good news is, if parents plan ahead and are saving enough for retirement, they can tap their individual retirement account (IRA) to help pay for higher education expenses without a tax penalty.

According to the College Board, the average cost for tuition, room and board for a private, nonprofit, four-year college is nearly $44,000 per student. No wonder baby boomers and Generation X fear they may have to work until their eighties to foot those bills, or worse, be unable to retire.

Congress acknowledged this financial burden and has allowed investors to use money saved in IRAs to pay for some educational expenses. Generally, if an account owner takes a distribution from his or her IRA before age 59½, the distribution is subject to income tax plus a 10% early distribution penalty. However, the IRS offers a number of exceptions whereby the penalty would not apply (although income taxes continue to apply). One of those exceptions is when proceeds are used to pay for higher education. In addition to using your IRA for your own higher education expenses, the distribution extends to your spouse or your child. There is no limit as to how much money you may withdraw from an IRA for education expenses. Remember, though, while you won’t have to pay IRS a 10% early distribution penalty, the distribution is still taxable.

Tip: You can use the educational expense exception for distributions from SEP and SIMPLE IRAs, as well as Roth IRAs.

The rule is clear: higher education is considered only post-secondary; K-12 expenses are not allowable under the law. Under Tax Cuts and Jobs Act of 2017, eligible 529 expenses include up to $10,000 (per-student, per-year basis) to pay for K-12 educational expenses.

Qualified higher education costs include post-secondary tuition, fees, books, supplies, and required equipment. Computers and related equipment also count as long as the student uses them during the year that he or she is in school. Room and board can also count. The education expenses can be for you, your spouse, your children, or grandchildren. There is no dollar limit on how much of your IRA you can use. The education expense and the IRA distribution must occur in the same calendar year. For example, if you want to use the education expense exception to pay tuition in January, 2018, you can take a distribution from your IRA anytime between January 1 and December 31, 2018 and it will qualify for the exception.

The higher education exemption does not apply to 401(k) and similar defined contribution plans. Instead, a 401(k) plan may (but is not required) to allow for hardship distributions. Unlike an IRA, a hardship distribution is subject to a 10% early distribution penalty in addition to income taxes.  Further, under a “safe harbor” in IRS regulations, an employee is automatically considered to have an immediate and heavy financial need if the distribution is related to “tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education for the employee or the employee’s spouse, children, dependents or beneficiary.”

The IRS defines an eligible educational institution as “any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions.”

Generally, higher education expenses include the usual array of expenses, including fees, tuition, books, etc. When Congress passed the Protecting Americans from Tax Hikes Act of 2015, the rule on eligible higher education expenses was updated to include computers, certain software, and even Internet access. Prior to the 2015 act, the rule stated that if an expense was not required by the school, it was not a qualified education expense.

If you have any questions about this or another retirement topic, please e-mail me at roadtoretirement@lordabbett.com.


To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

GLOSSARY OF TERMS

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

A SIMPLE IRA plan is an IRA-based plan that gives small-business employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or nonelective contributions. All contributions are made directly to an individual retirement account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.

A simplified employee pension plan (SEP IRA) is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP-IRA plan for your business, you and any eligible employees establish your own separate SEP-IRA; employer contributions are then made into each eligible employee’s SEP IRA.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A 403(b) plan is a retirement savings plan that allows employees of public schools, nonprofit, and 501(c)(3) tax-exempt organizations to invest on a pretax and or Roth aftertax basis. Contributions to a 403(b) plan are conveniently deducted directly from your paycheck. In addition, your employer may elect to make a contribution on your behalf.

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.

RELATED TOPICS

About The Author

image

Please confirm your literature shipping address

Please review the address information below and make any necessary changes.

All literature orders will be shipped to the address that you enter below. This information can be edited at any time.

Current Literature Shipping Address

* Required field