IRA Early Withdrawal Penalty Related Question

[AsifN]

My son started medical school this fall. We, as parents do not want him to take loan. This means, we will be paying for his tuition. I plan to take gradual early withdrawals from my IRA accounts. My son is 24 now but he won't be 24 next year and the year after and so on. I know that I cannot claim him as a dependent after he crosses the age of 24. My question is, will my early withdrawals towards his medical school expenses be subject to 10% penalty, because he will no longer be claimed as a dependent on my taxes? I understand I will be paying taxes, of course.

[dmertz · Accepted solution]

Distributions from your IRA during the year up to the amount paid for your son's education expenses during the year are exempt from the 10% early-distribution penalty.  Your child is an eligible individual with regard to this penalty exception whether or not the child is your dependent.

https://www.irs.gov/publications/p590b#en_US_2022_publink100090258

[VolvoGirl]

And you might be able to still claim him after he turns 24 if his income is less than

2023 $4,700 And 2022 $4,400

See IRS Publication 501 starting on page 11 bottom Dependents

https://www.irs.gov/pub/irs-pdf/p501.pdf

Who can I claim as a dependent?

https://ttlc.intuit.com/community/credits-and-deductions/help/who-can-i-claim-as-my-dependent/00/267...

[AsifN]

Thank you so much. You have no idea how helpful and relieving your answer is. We are technically going to go broke with his medical school expenses in the next 4 years and being able to hold 10% of it back is huge!!

[AsifN]

@VolvoGirlUnderstood. So this year he did work and made way more than that amount while he was waiting for his acceptance. If he turns 25 in November of this year, can he still be claimed as dependent for 2023 when we file taxes next year?

[Bsch4477]

Dependency doesn’t matter for the penalty exemption when withdrawals are made for qualified education expenses for you, your spouse, child or grandchild. 

Also, you can still claim him after age 24 if you provide more than half of his support and he had income less than $4,400 (in 2002). That amount will increase for 2023. 

[NCperson]

@AsifN before you do ANYTHING, please be sure you understand the Repayment plans available and the PSLF (Public Service Loan Foregiveness Program) from government loans.  I appreciate you stated you don't want him to take the loan. 

The repayment plans may be as little as the lesser of the fully amortizing payment over a 10 year period OR 10% of income (over gov'ts family poverty level calculation).  In the early years post medical school, the 10% of income is the lesser and after residency (and fellowship) those last years are limited by the fully amortizing payment.  it is a great, great deal. 

PSLF which covers public workers and those working for non-profits, and most every hospital is a non-profit.

 Once your child has worked in a hospital or other non-profit situation for 10 years (120 payments), whatever the remaining balance is gets WRITTEN OFF with no tax implications!! 

While the repayment plans are advertized as 20-25 years until the writeoff (and after 2025, the write-off is taxable income!), if the student is eligible for PSLF, it is written off after 10 years and the write-off is NOT taxable income. 

it is FAR CHEAPER than liquidating an IRA.  His debt burden goes away quickly post residency.  (I have experience with this as my child is now a doctor and I figure upwards of half his debt will be written off in 3 more years with no tax implications).  

[Opus 17]

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@AsifN wrote:

@VolvoGirlUnderstood. So this year he did work and made way more than that amount while he was waiting for his acceptance. If he turns 25 in November of this year, can he still be claimed as dependent for 2023 when we file taxes next year?

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Qualified education expenses are not subject to the 10% penalty.  Your child's expenses are qualified whether or not they are your tax dependent.  However, the definition of "qualified education expenses" is different for different tax benefits, so make sure you know the correct definition here.  It is:

Qualified higher education expenses.

Qualified higher education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance. In addition, if the individual is at least a half-time student, room and board are qualified higher education expenses.

Also note that if your child receives any other tax-free assistance (like a grant, scholarship, fellowship, or certain employee benefits) that reduces the amount that is eligible for the penalty exclusion.  

As to whether or your not your child can be claimed as a dependent on your tax return, if the child is over 23 (that means 24 or more) then they only qualify as your dependent if you provide more than half their support AND they have less than $4400 of taxable income (for 2022) or less than $4700 of taxable income (for 2023).  Claiming your child as a dependent gets you a $500 tax credit and may make you eligible to claim the Lifetime Learning Credit on the tuition you pay.  But whether or not you claim your child as a dependent, you still get the penalty exception.

[Opus 17]

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@NCperson wrote:

@AsifN before you do ANYTHING, please be sure you understand the Repayment plans available and the PSLF (Public Service Loan Foregiveness Program) from government loans.  I appreciate you stated you don't want him to take the loan. 

This is a good idea but also a very tricky issue.  It might be worth finding a financial analyst who specializes in medical student financial aid programs who can explain the pros and cons.  There are also some career programs that will pay the doctor's loan payments if they work in a qualifying position.  And some hospitals may include loan repayment as a recruitment tool, if your child chooses an in-demand specialty.  

There are several programs that will forgive student loans for medical students.  Some may require the graduated doctor to practice in an under-served area, like a rural community or minority community with a shortage of doctors.  Others may require the graduated doctor to perform "public service", which might mean they work for a university or government, but may not be eligible if they work for a for-profit hospital.  (The loan forgiveness you qualify for by working in a rural community with a shortage of primary care physicians might not be available for a Hollywood dermatologist who provides retinol and botox to celebrities, for example.).   You need to match the expectations of the loan forgiveness program to the career aspirations of the doctor.

Then of course, the doctor has to work a qualifying position for 10 years.  If they change their mind, they won't qualify any longer.  And of course, the graduated doctor must make 10 years of loan payments with interest, before qualifying.  

We could consider a scenario where your child takes loans, and you offer to make the payments from your IRA funds.  That spreads the IRA withdrawals over 10 years instead of 4 years.  The portion of your IRA balance that stays in the IRA continues to grow--if the loan interest rate is 8% and your IRA can grow at 6%, you only lose 2% per year.  If you can get 8% or better in your IRA, you come out ahead.  Then at 10 years, if your child doesn't qualify for loan forgiveness for whatever reason, you can pay off the remaining loan balance then. 

It's something that a medical school financial aid specialist could help you figure out. 

[NCperson]

@Opus 17 well written as always. 

The other thing that has to be considered is that most doctors make a TON of money post residency, so the monthly debt burden isn't that large compared to their incomes.   Unlike many others who pile on debt during graduate school, this class (physicians) do make 100s of thousands of dollars as soon as they complete residency  and the monthly required payments under the PSLF program are capped at the fully amoritizing 10 year payment.   For most other professions that monthly debt burden is quite high once the student enters the work force because their income doesn't skyrocket like a physician's will.

I appreciate student loan repayments are in the news a lot as a real pain for many, but for those eligible for PSLF can really come out as real winners - much better return than liquidating an IRA to pay for it.  

[Opus 17]

The biggest problem with PSLF is the "PS" part.  In my city, two of the three major medical centers are for-profit, and while some of the fellows I have worked with are still in academic medicine, many of them have moved on to for-profit practices.  The aspiring medical student needs to know about all the programs (not just the federal PSLF program which applies to all public service jobs, but also state and local programs specific to physicians) and match the program to their career plans. 

But, it is definitely a concept that should be explored before draining the parents's retirement funds!