Withdrawals

The designated beneficiary of an education IRA can take withdrawals at any time. Whether the withdrawals are tax free depends, in part, on whether the withdrawals are more than the amount of qualified higher education expenses (defined earlier) that the beneficiary has in the tax year.

Withdrawals Not More Than Expenses

Generally, withdrawals are tax free if they are not more than the beneficiary's qualified higher education expenses for the tax year.

Withdrawals More Than Expenses

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

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

1. Multiply the amount withdrawn by a fraction. The numerator is the total contributions in the account and the denominator 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 Subtract the amount figured in (1) from the total amount withdrawn during the year.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 The numerator is the qualified higher education expenses paid during the year and the denominator is the total amount withdrawn during the year.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.

Example. You receive a $600 withdrawal from an education IRA to which $1,000 has been contributed. The balance in the IRA before the withdrawal was $1,200. You had $450 of qualified higher education expenses for the year. Using the steps above, you figure the taxable portion of your withdrawal as follows.

1. $600 x ($1,000 x $1,200) = $500
2. $600 - $500 = $100
3. $100 x ($450 x $600) = $75
4. $100 - $75 = $25

You must include $25 in income as withdrawn earnings not used for the expenses of higher education.

Withdrawal and Deduction or Credit

You generally cannot take a deduction or credit for any educational expenses that you use as the basis for a tax-free withdrawal from an education IRA. But see Waiver of tax-free treatment, next.

Waiver of tax-free treatment. The designated beneficiary can waive the tax-free treatment of the withdrawal and elect to pay any tax that would otherwise be owed on the withdrawal. The beneficiary or the beneficiary'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.

Additional Tax

Generally, if the beneficiary receives a taxable withdrawal, he or she also must pay a 10% additional tax on the amount included in income.

Exceptions. The 10% additional tax does not apply to withdrawals described in the following list.

1. Paid 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. A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration.
3. Made because the designated beneficiary received:
   1. A qualified scholarship excludable from gross income,
   2. An educational assistance allowance, or
   3. Payment for the designated beneficiary's educational expenses that is excludable from gross income under any law of the United States.

   The exception applies only to the extent the withdrawal is not more than the scholarship, allowance, or payment.

4. Included in income only because the beneficiary waived the tax-free treatment of the withdrawal (as explained earlier).
5. A return of an excess contribution (and any earnings on it) made before the due date of the beneficiary's tax return (including extensions). If the beneficiary does not have to file a return, the excess (and any earnings) must be withdrawn by April 15 of the year following the year of the contribution. The beneficiary must include in gross income for the year the contribution is made any income earned on the excess contribution.

When Assets Must Be Withdrawn

Any assets remaining in an education IRA must be withdrawn when either one of the following two events occurs.

1. The designated beneficiary reaches age 30. In this case, the designated beneficiary must withdraw the remaining assets within 30 days after he or she reaches age 30.
2. The designated beneficiary dies before reaching age 30. In this case, the remaining assets must generally be withdrawn within 30 days after the date of death.

The earnings that accumulated tax free in the account must be included in taxable income. You determine these earnings as shown in the following two steps.

1. Multiply the amount withdrawn by a fraction. The numerator is the total contributions in the account and the denominator 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. The result is the amount of earnings included in the withdrawal. The person receiving the assets must include this amount in income.

Exception for transfer to surviving spouse or family member. If an education IRA is transferred to a surviving spouse or other family member as the result of the death of the designated beneficiary, the education IRA retains its status. (For this purpose, family member was defined earlier under Rollovers.) This means the spouse or other family member can treat the education IRA as his or her own. There are no tax consequences as a result of the transfer.

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