Dear Carrie: How do I withdraw money from my SEP to reimburse myself for my daughter's education? --A Reader
Dear Reader: To give you a specific answer to your question, I'd have to have a bit more information. First, I'd need to know the type of educational expenses and when you paid them. Second, I'd want to discuss your overall financial picture and how prepared you are for retirement.
This would help determine: 1) if you qualify to take money from your SEP penalty free and 2) if taking money from your SEP now is a good idea at all.
The good thing about a SEP-IRA is that it allows small businesses and self-employed individuals to make higher annual contributions than a traditional or Roth IRA. However, the rules for early withdrawal are the same and this is where you have to be careful. Reimbursing yourself could end up costing you a bundle.
WHAT QUALIFIES AS AN EDUCATIONAL EXPENSE
Generally speaking, if you take a withdrawal before age 59-and-a-half, you're subject to a 10 percent penalty. In the case of a SEP or traditional IRA, you also would pay ordinary income taxes on the withdrawal. If you're not concerned with penalties or taxes, you could just take the money from your SEP, report it on your income tax return, and pay the additional costs. (Not the best idea for your retirement!)
However, there are exceptions that allow for penalty-free withdrawals and paying for higher education is one of them. In fact, you can withdraw funds from an IRA penalty-free to pay for qualified higher education expenses for yourself, your spouse and your or your spouse's child, foster child, adopted child or descendant of any of them.
I'm assuming you're talking about college costs for your daughter. If so, qualified expenses would include things like tuition, fees, books, supplies -- even room and board if your daughter is at least a half-time student. One stipulation is that the school must be an eligible educational institution. The IRS defines this as any college, university, vocational school or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education.
As you can see, the definition is pretty broad, so chances are your daughter's expenses would qualify.
WHEN YOU CAN TAKE A PENALTY-FREE WITHDRAWAL
What concerns me is your use of the word "reimburse" because when you incur the educational costs and when you take your IRA withdrawal are also important factors in avoiding the 10 percent penalty.
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