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Avoiding 10% Penalty Tax for Early Withdrawal of IRAs

Posted by attorney Thomas West

IRAs and Early Withdrawal Penalty Tax

If you have a traditional IRA, you know that you cannot withdraw money from it until you become age 59 1/2, or you must count the entire amount as income. You also must file Form 5329 with your tax return and pay a penalty tax of 10% of the early withdrawal. For example, if you withdraw $9500 from a traditional IRA, you will owe a 10% penalty tax, or $950, on that withdrawal.

Exception for Qualified Higher Education Expenses

Fortunately, there are several exceptions to that 10% early withdrawal penalty tax. One of them applies if you are attending a college or university on an at least half time basis. The amount excluded from the penalty tax is your qualified higher education expenses or the amount of the early withdrawal, whichever is less.

Qualified Higher Education Expenses Defined

The qualified higher education expenses you get to deduct off the withdrawal subject to the penalty tax is defined by federal education law, and it is found in a university's catalog as its "estimated cost of attendance." This amount may differ sharply from your actual expenses, and it is likely to be higher, especially if you are a commuter student. Plus, if you buy a personal computer for use in schoolwork, that expense can be included. By the time the allowed expenses are totaled up, the entire early withdrawal penalty tax is likely to be completely eliminated. Thus, while the withdrawan amount is taxable in the year you withdraw it, the penalty tax can at least be eliminated.

Additional resources provided by the author

20 U.S.C.A. § 1087ll
26 U.S.C.A. § 72(t)(2)(E)
26 U.S.C.A. § 72(t)(7)
26 U.S.C.A. § 529(E)(3)

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