17 Apr Inherited IRAs, taxes and college funding
Q. I inherited a large IRA, and I’d like to use some of that money to pay for college for my kids. Is there a way to transfer them the money so there are no tax implications?
A. You will not be able to completely avoid paying income tax on the withdrawals made to pay for college, but the timing of the withdrawals is very important.
With an inherited IRA, assuming it was not inherited from a spouse, you generally must start taking distributions by the end of the year following the year of decedent’s death with Required Minimum Distributions based on your life expectancy computed in the year of the decedent’s death (reduced by one for each subsequent year), said Catherine Romania, an estate planning attorney with Witman Stadtmauer in Florham Park.
Alternatively, the entire amount must be withdrawn within five years of decedent’s death, she said.
“Amounts withdrawn are taxable in the year of withdrawal,” she said. “There is no 10 percent early withdrawal penalty but failure to meet either of the above withdrawal schedules may result in a 50 percent penalty being imposed in addition to the tax.”
Romania said even if you are under age 59½, withdrawals used for qualified education expenses will not trigger the 10 percent early withdrawal penalty. It will result in taxable income to the extent of the withdrawal.
Qualified education expenses include tuition, fees, and books as well as room and board if enrolled at least half time, she said.
“If the inherited IRA was from the estate of a decedent required to file a federal estate tax return and pay federal estate tax, then discuss with your accountant or tax advisor the applicability of IRC §691 (c), which provides the beneficiary with an itemized deduction for income tax purposes based on estate tax attributable to `income in respect to decedent’ reported on the federal estate tax return,” she said. “IRAs comprise income in respect to decedent.”
Finally, Romania said, consider the timing of the withdrawals for both income tax and financial aid consequences.
“Consider the size of the anticipated withdrawal in a particular year and whether it puts you into a higher tax bracket,” she said. “If so, it may be better to spread the withdrawal over multiple years.”
Withdrawals will increase your taxable income, which in turn may result in reduced financial aid, Romania said. If possible, use the withdrawal in your child’s final year of college when financial aid is no longer being sought, she said.
Learn about how other IRAs have different rules when it comes to college funding.
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This story was first posted in April 2015.NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.