Early Roth Withdrawls

[Guest scooter]

I contributed $2,000 to a traditional IRA a couple of years ago and converted that account, now over $4,000, to a Roth IRA last year. Soon after making the original contribution I lost my job and decided to return to graduate school. I am now finishing school and would like to pay off some of the bills I accumalated while studying. Can I make a withdrawl of the original $2,000, the whole $4,000 or nothing for five years without incurring the 10% penalty?

[Guest Del Rae]

Scooter,

In general, early distributions from conversion IRAs are subject to 10% for early withdrawl for both the $2,000 or the $4,000 in your situation.

However, there is an exception to the early withdrawal penalty for higher education expenses. Higher education expenses must be incurred by a college, university, vocational school or other postsecondary educational institution, and do include graduate level courses. The expenses include tuition, books, supplies, equipment that is required for enrollment or attendance, as well as room and board if the student is enrolled at least half-time.

Please note that the qualified education expenses must be reduced from tax-free scholarships, veteran benefits, or other tax-free assistance first. (Code Sec. 72(t)(2)©)

Cool, huh!

P.S. You know if you take the money out early and are using the 4-year spread, that the taxability is then speeded up, right?

[John G]

Pause before you bust up an IRA or Roth IRA. You just created this wonderful tax shelter... if at all possible, give it the 30, 40, 50 or more years to work its wonder. You have other options such as student loans, working more hours, etc. I would want to exhaust all my other options before I dipped into IRA/Roth accounts. Ten years from now you may kick yourself for not considering other options.

Back in the mid 1980s, I had a chance to take out a lump sum (job schange) that was tax sheltered and pay tax on a ten year average (a tax option then). Sounds wonderful? The big mistake was that for the last 14 years I have paid taxes on all the wonderful gains that could have been sheltered. The total tax bill in 14 years grew to twice! what I made in 1985. Ouch.

I hope you now understand why I recommend not spending your IRA assets now. Good Luck.