How to Use the First-Time Home Buyer and Education Exceptions
 Only IRA type retirement accounts qualify for this exception. Qualified retirement plans such as 401(k) plans, 402(b) plans, 457 plans, etc. are not permitted to make these penalty-free withdrawals. The education exception to the 10% penalty on premature withdrawals for IRA accounts has specific rules that must be taken seriously (SIMPLE plan premature withdrawals have a 25% penalty). There a numerous ways to trip up and become exposed to the penalty. First and foremost, the withdrawal(s) must be for qualified education expenses.
Qualified Education Expenses
The following items are the permissible “qualified higher education expenses” for which an IRA withdrawal can be used:
• Tuition
• Fees
• Room and board if student is attending at least halftime
• Books
• Supplies
• Equipment such as computers for attendance or enrollment at a college or university
A payment which reimburses a payment from any of the following sources will be considered to be “qualified higher education expenses”:
• Payments for services
• A loan
• A gift
• A withdrawal from a personal savings account (or a Qualified Tuition Program)
• An inheritance given to the student or the person making the withdrawal
Payments That Are Not Qualified to be Reimbursed
• Pell grants
• Tax-free payments from Coverdell Education SavingsAccounts
• The tax-free portion of grants and scholarships
• Employer-provided educational assistance
• Veterans educational assistance
• Tax-free distributions received as educational assistance
Comments: There appears to be no limit on the amount of withdrawals for education. The first-time homebuyer withdrawal is limited to $10,000. The cost basis contributions to ROTH IRAs may be withdrawn at any time without penalty and without worrying about the above criteria. If a 10% premature withdrawal penalty does apply, it only applies to amounts includible in income. If a ROTH IRA or a nondeductible IRA was worth less than the amount of contributions at the time of withdrawal, no penalty would apply.
The First-time Homebuyer Exception
The 10% premature penalty does not apply on up to $10,000 ($20,000 if a spouse withdraws from his or her IRA) of distributions an IRA owner receives to buy, build, or rebuild a first-time home. To qualify the distribution must meet all of the following requirements:
1) It must be used to pay for qualified acquisition cost before the close of the 120th day after the day the IRA owner received it.
2) It must be used to pay ualified acquisition cost for the main home of a first-time homebuyer who is any of the following:
• the IRA owner
• the IRA owner’s spouse
• the IRA owner’s and spouse’s children
• the IRA owner’s and spouse’s grandchildren
• the IRA owner’s and spouse’s parents or other ancesters
Qualified acquisition costs include costs of buying, building, or rebuilding a home, and any other reasonable settlement, financing, or other closing costs. The $10,000 applies to all present and prior qualifying distributions, i.e. the $10,000 limit is accumulative. You are a first-time homebuyer if you had no present interest in a main home during a two-year period ending on the date of acquisition of the home for which the distribution is being used. Both spouses must meet this test.
The John McGovern et ux. V. Commissioner Case; T.C. Summary Opinion 2003-137
John McGovern was a full time student at Villanova University School of Law. During 1999 he received lump sum distribution for a qualified retirement plan and he deposited the check into his personal account. He then used part of it to pay tuition and the other part he rolled into his IRA account. The IRS asserted the 10% premature distribution penalty and McGovern appealed to the Tax Court. McGovern lost even though he put forth the “substance over form” argument, essentially saying the withdrawal did not have to come from an IRA on paper and that he had effectively done it. The Court correctly pointed out that he did not withdraw the monies for education from an IRA account, and did not accept the “substance over form” argument. The lesson should be obvious. Shortcuts don’t work.
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