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Back to School: Educational Expense Exception to the 10% Penalty (Part 3 of 4)

Can you believe it? We're now 7 full months into 2012 already. And while there's more fun in the sun to be had before summer comes to an end, August has traditionally signaled the start of the back to school season. With that in mind, we thought we'd spend a little time talking about the educational expense exception to the 10% penalty.

We first discussed the basic tenets of the exception, whose expenses and what types of expenses qualify in the first installment of this series. CLICK HERE to read the first article on the educational expense exception to the 10% early IRA distribution penalty.

educational expense exceptionIn the second part of the series, we delved into what is considered an "educational expense" and what type of schooling is covered under the exception.

In this installment, we will get a little more technical and talk about the exceptions use with 401(k)s, Traditional IRAs as well as SEP and SIMPLE IRAs.

My money is currently in a 401(k). Can I just take the distribution from there?

No, no, no, no, no! Absolutely not. And in case that isn’t clear enough… NO!!! The education expense exception to the 10% penalty applies to distributions from IRAs only. If you take a distribution from a 401(k), 403(b) or similar plan and try to claim the educational expense, your fighting a battle you can’t possibly win. There have been numerous Tax Court cases arguing everything from “it’s not fair” to “what’s the difference” and none of them have been successful. The Tax Code says there’s a difference, and that’s that.

Can a 401(k) or similar plan be rolled to an IRA so that the educational expense exception can be used?

From a Tax Code perspective, the answer is an absolute “yes.” A 401(k) distribution can be rolled to an IRA today, and a distribution taken from that IRA tomorrow can qualify for the educational expense exception. However, 401(k)s and similar plans do not have to allow you to take a distribution just because you feel like it. In order to roll money over to an IRA, you have to be able to take a distribution from the plan. If you’re still working for the company and you are under 59 ½, your rollover options, if any, are likely to be very limited. To find out what the distribution rules are for your plan(s), you can ask to see the summary plan description or plan document.

Does the educational exception apply to SEP and SIMPLE IRA distributions?

Yes. You can use the educational expense exception for distributions from SEP and SIMPLE IRAs. All exceptions to the 10% penalty are applied to SEP and SIMPLE IRAs in the same fashion they are applied to traditional IRAs.

-By Jeff Levine and Jared Trexler


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Thursday's Slott Report Mailbag

Consumers: Send in Your Questions to [email protected]

Can I transfer money from my IRA to my husband's Roth IRA? I am 35, and he is 36.

Thank you!

Gail Clements

No. The only way your IRA funds can be transferred to your husband’s IRA is in a divorce or after your death. Even then, it would have to be transferred to a similar IRA, for example an IRA to IRA or a Roth IRA to another Roth IRA. In this case, you cannot transfer your IRA into your husband’s Roth IRA.