Florida 2-15 Life, Health and Variable Annuity AgentGeneral Knowledge of Life InsuranceHard
A 55-year-old client has a substantial amount in a traditional IRA. They need to withdraw $15,000 to cover qualified higher education expenses for their child. How will this withdrawal be treated for tax purposes?
- AThe withdrawal will be completely tax-free and penalty-free.
- BThe entire $15,000 will be subject to ordinary income tax and a 10% early withdrawal penalty.
- CThe withdrawal will be tax-free, but still subject to the 10% early withdrawal penalty.
- DThe entire $15,000 will be subject to ordinary income tax, but the 10% early withdrawal penalty will be waived.
Show answer & explanationAnswer & explanation
Correct answer: D. The entire $15,000 will be subject to ordinary income tax, but the 10% early withdrawal penalty will be waived.
Withdrawals from a Traditional IRA are generally subject to ordinary income tax. However, if the withdrawal is used for qualified higher education expenses, the 10% early withdrawal penalty (which normally applies to withdrawals before age 59½) is waived. The amount is still reported as taxable income.
Why the other options are wrong
- A. Traditional IRA withdrawals are rarely completely tax-free; they are almost always subject to ordinary income tax unless they are a return of non-deductible contributions.
- B. The 10% penalty is waived for qualified higher education expenses.
- C. Traditional IRA withdrawals are generally taxable income, even if penalty-free.
Traditional IRA Early Withdrawal for Higher Ed
Withdrawals from a Traditional IRA before age 59½ used for qualified higher education expenses are subject to ordinary income tax but are exempt from the 10% early withdrawal penalty.
- Applies to Traditional IRAs
- Must be used for 'qualified higher education expenses'
- Withdrawals are taxable as ordinary income
- 10% early withdrawal penalty is WAIVED
- Can be for the account holder, spouse, children, or grandchildren
Memory trick: Higher Ed: Pay the tax, but the penalty is fled.