Q&A: Roth IRA penalties

Dear Liz: I read your column in which you talked about the Roth IRA and how withdrawals can be penalized if you’re younger than 59½ or the account is not 5 years old. But are there any exceptions? Can we withdraw from our Roth IRA and not pay any tax or penalty if we use the money to pay for our children’s college?

Answer: You can avoid the early withdrawal penalty, but you’ll owe taxes on any earnings you withdraw from a Roth IRA when you use the money for qualified higher education expenses.

To recap, you can always withdraw an amount equal to your total contributions to a Roth IRA without owing any taxes or penalties. You don’t even have to wait five years.

When you withdraw earnings, however, you can avoid taxes and penalties only if the account is at least 5 years old and you’re 59½ or older, or you’re taking the distribution because you’re totally and permanently disabled, you inherited the Roth IRA from the account owner or you’re using as much as $10,000 for a first-time home purchase.

If you don’t meet those qualifications, there are still ways to avoid the penalty if not the taxes.

Withdrawing money to pay qualified education expenses is one of those exceptions, as is paying medical expenses that exceed 7.5% of your adjusted gross income, withdrawing as much as $5,000 after the birth or adoption of a child, paying an IRS levy, taking a qualified reservist distribution if you’re a military reservist called to active duty or taking a series of substantially equal periodic payments.

Let’s say you’ve contributed $20,000 to a Roth that’s now worth $30,000. The first $20,000 you withdraw is tax- and penalty-free. The final $10,000 you withdraw would be taxable, but it would not face the 10% early withdrawal penalty if you used it for your children’s college tuition, fees, books, supplies or other qualified expenses.

Q&A: Direct tuition payment pros, cons

Dear Liz: You recently answered a question from someone whose parents misused trust funds intended for their child’s education. I chose to pay the colleges directly each semester once my grandchildren enrolled rather than give money to the parents. I decided that was the only way I could be assured the money went for what grandma intended.

Answer: Your grandchildren are fortunate to have a generous grandmother, but your strategy has some drawbacks as well as advantages.

Direct tuition payments aren’t considered gifts to the child, which means no gift tax return is required. Your payments could, however, reduce any need-based financial aid the children could get. Also, your approach requires that you be ready and able to make the tuition payments when the children reached college age. Your death or a financial setback could have turned your good intentions into an empty promise.

Wake up to the truth about ‘dream schools’

The college admissions scandal — which recently led to a 14-day prison sentence for actress Felicity Huffman — exposed a group of wealthy parents’ obsession with getting their kids into the “right” school. Prosecutors say the families paid bribes, faked test results and pretended their kids were athletes to get them into selective colleges.

Unfortunately, many less affluent families also fall for the delusion that some schools offer golden tickets for their children’s futures, says Lynn O’Shaughnessy, author of “The College Solution.” Whether it’s an Ivy League college or a high-priced “dream school,” too many people believe certain educations are worth endless effort, stress — and debt.

In my latest for the Associated Press, the most important facts to know as you navigate the college admissions process and decide how much to spend.

Q&A: How to keep a loan to family from turning into a problem

Dear Liz: My husband and I have saved close to $2 million. He is 58, and I am 59. Our son is a hardworking, bright young man awaiting responses to medical school applications. My husband wants to loan him $200,000 to $500,000 to reduce his debt from interest on loans. I want to help too, but I think $200,000 should be the limit.

I want a legal contract to determine when it will be paid back, how much interest we will charge, and so on. My concern is that we are unsure how to set this up and I don’t want a nice gesture to end up causing problems with our son down the road. My husband is still working and has a nominal pension from military retirement.

Answer: The first rule of friends-and-family loans is to offer only what you can afford to lose. Even with all the proper documents, many loans turn into inadvertent gifts when the borrower can’t or won’t make the payments.

So your first stop should be a fee-only financial planner, who can review your entire financial situation, including your retirement plans, and let you know how much you can afford to lend your son.

The exact amount will depend on when your husband plans to stop working, how much you anticipate spending and how much you expect to receive from the pension and from Social Security, among other issues.

The planner also can tell you what interest rate you’ll need to charge to avoid having to file gift tax returns with the IRS.

Once you have that information, you and your husband can work together to determine the size of the loan and the interest rate. You can find promissory note templates online, or you can hire an attorney to draft the actual agreement.

Tuesday’s need-to-know money news

Today’s top story: Will a summer job burn your financial aid for college? Also in the news: 4 cool-down summer escapes you can book with points, new tools that can help turn your retirement savings into a steady paycheck, and how how to find out if you’re eligible for a $20,000 payment from Equifax data breach.

Will a Summer Job Burn Your Financial Aid for College?
The unexpected impact.

4 Cool-Down Summer Escapes You Can Book With Points
Beating the heat with reward points.

New tools can help turn your retirement savings into a steady paycheck
Personalized tools to create best-case scenarios.

Are you eligible for a $20,000 payment from Equifax data breach?
Don’t get too excited.

Thursday’s need-to-know money news

Today’s top story: Teach your teens about college costs long before they apply. Also in the news: Haggling for vacation souvenirs, getting cheap car insurance for new drivers, and what to do with unexpected money.

Teach Your Teens About College Costs Long Before They Apply
Prepare them for reality.

Save Money on Souvenirs: Learn to Haggle
Make a plan and stick to it.

Getting Cheap Car Insurance for New Drivers
Discounts can add up over time.

What to Do With Unexpected Money
Be methodical.

Teach your teen about college costs starting now

Many families struggle to pay college expenses for one or two kids. Certified financial planner Sarah Carlson, mother of two sets of twins, will soon have all four of her children in college at the same time.

The older twins are already there, to be joined soon by the younger two. But years ago, Carlson started teaching her children how to get an affordable education. One of the first steps was making clear what she would contribute.

“I let them know early on what I was comfortable spending and what I wasn’t,” says Carlson, who’s based in Spokane, Washington.

In my latest for the Associated Press, why you need to teach your teen about college costs long before the first application essay is written.

Wednesday’s need-to-know money news

Today’s top story: The lowdown on new tools to jump-start your credit. Also in the news: The new credit card that pays cash-back rewards for on-time payments, tuition discounts grow at private colleges and universities, and what to do in your 20s and 30s to be set in your 60s and 70s.

The Lowdown on New Tools to Jump-Start Your Credit
Learn how they work and if you should use them.

No credit history? This new credit card pays cash-back rewards for on-time bill payments
Introducing Petal.

Tuition discounting grows at private colleges and universities
Tuition costs are dropping.

What to do in your 20s and 30s to be set in your 60s and 70s
It’s never too early to prepare.

Tuesday’s need-to-know money news

Today’s top story: Why your financial aid may plummet after freshman year. Also in the news: 3 tricks to help you shop less, how FICA tax and other withholding taxes work on your paycheck, and why you should plan to retire even if you don’t plan on retiring.

Why Your Financial Aid May Plummet After Freshman Year
Preparing yourself.

These 3 Tricks Can Help You Shop Less
Curbing an expensive habit.

How FICA Tax and Other Withholding Taxes Work on Your Paycheck
What they are and how you can change them.

Plan to Retire Even If You Don’t Plan to Retire
Plans have a way of changing.

Thursday’s need-to-know money news

Today’s top story: More parents are putting limits on college help. Also in the news: Mastercard’s new rule will make some “free” trials more transparent, what you need to know about SIPC insurance, and why you should be wary of new tricks for raising your credit score.

More Parents Are Putting Limits on College Help
Limiting contributions.

Mastercard’s New Rule Will Make Some ‘Free’ Trials More Transparent
Reminding you when the trial is up.

SIPC Insurance: What It Does and Does Not Protect
Covering your brokerage.

Be Wary of New ‘Tricks’ for Raising Your Credit Score
They could end up doing the opposite.