Advanced Underwriting Consultants

Ask the Experts – October 23

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

 Question:  If an account holder, age 45, withdraws funds from his Roth IRA for his son’s college tuition, would he be subject to any taxes?

Answer: It depends on how much the account holder had contributed to the IRA and how much he withdrew.

Distributions taken from Roth IRAs before the account holder has reached age 59 ½ are generally considered non-qualifying distributions, meaning the withdrawals are made according to the following ordering sequence: (1) aggregate annual contributions; (2) conversion amounts; and (3) earnings on annual contributions and conversion amounts.

Non-qualifying distributions from annual contributions are always income tax-free and never subject to the 10-percent early withdrawal penalty. Similarly, non-qualifying distributions from conversion amounts are also income tax-free, but these amounts may be subject to the 10% early withdrawal penalty if made within five years of the conversion and while the owner is under age 59 ½.

Earnings distributed prior to age 59 ½ are generally subject to both income taxes and the 10-percent early withdrawal penalty. However, if the funds are used for qualified higher education expenses, the account holder is not subject to the 10-percent penalty, but he would still incur income taxes from the amount the distribution exceeds his total contributions.

What does this mean? Let’s say the account holder contributed $20,000 throughout his life to his Roth IRA and this year he withdraws $10,000. Even if these funds were not used for qualified higher education expenses, the account holder would not incur income taxes or the early withdrawal penalty on the distribution. This is because the entire amount is considered withdrawn from the aggregate annual contributions.

If, however, the account holder withdraws $30,000 for his son’s college tuition, then the account holder would add $10,000 to his gross income (i.e. $20,000 is distributed from annual contributions and $10,000 from earnings). However, he would not incur the 10-percent penalty because he used the funds for qualified higher education expenses.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.