Over the next few months, many parents will start paying college expenses. If you’re among them, there are rules regarding withdrawing funds from 529 accounts. Mistakes will result in a 10 percent penalty, plus you’ll have to pay interest on the earnings (for funds that you used for the wrong kinds of expenses).
The question that comes up time and again when we speak with parents is, “What expenses will those 529 accounts cover?”
As long as 529 plan withdrawals are used for “qualified higher education expenses” (QHEE) during the year in which they are withdrawn, account earnings are tax-free. If money from a 529 plan is used for anything that does not meet the “qualified expense” criteria, the earnings portion of the non-qualified distribution will be taxed as ordinary income and subject to a 10 percent penalty. The principal portion of any withdrawals, which is made up of your after-tax contributions, will not be taxed or penalized.
Exceptions to the 10 percent penalty rule pertain to a beneficiary who becomes disabled, attends a U.S. Military Academy or gets a scholarship.
Here’s what you should know about making withdrawals from a 529 college savings account:
Only withdraw funds for 529 qualified expenses.
Tuition: For full time and part-time students at an accredited institution.
Room and board: On-campus dormitory room and board. Off-campus housing and meal costs are eligible up to the college’s published allowances in their “cost of attendance” figures (you should make a printout of this info and keep it with your important papers).
Rent or meals in excess of the allowances published by the college’s annual cost of attendance (typically found online from the admissions or financial aid office) are not qualified expenses.
Fees: All fees, such as administration, lab and technology fees required by the school, are an eligible expense.
Books and supplies: Required books and supplies are qualified expenses. Supplies such as pens, paper, printer ink and any books or supplies required by specific classes are also qualified expenses.
The school sets the budget for books and supplies, so check with them for the allowed amount.
Technology: Computers, software, printers, internet services and other programs required by specific classes are qualified expenses.
These expenses count as long as they are purchased during the time your child is enrolled in college and used for educational purposes.
Expenses of special needs beneficiaries: These include certain services and equipment that a special needs student would require, such as wheelchairs and transportation costs, which are generally considered a non-qualified expense.
Check with our offices before contributing to a 529 account for a special needs child because the benefits they receive from the government, such as Supplemental Security Income, restrict the income and assets owned by the beneficiary.
Other expenses, such as cellphones, transportation and insurance for example, are not to be paid with 529 account funds. If you’re unsure whether an expense qualifies, check with your 529 plan provider.
Tip: You have to spend money from a 529 account in the same calendar year (not school year) as the withdrawal, and you should keep your receipts.
Where Would You Like the Funds to Be Dispersed?
Decide where you’d like the account to send the funds. The account provider can pay:
- The school directly
- A check to you
- Your college-aged child.
Each of the above options has different potential consequences so please call our office to discuss your best plan.
Disqualifying for Tax Credits
Using a 529 account can disqualify you for tax credits. The American Opportunity Tax Credit gives you a $2,500 tax credit for spending $4,000 on qualified college costs. But if you pay for it with money from a 529 account, you don’t get the tax credit.
Eligibility for the tax credit begins to phase out for single parents with incomes above $80,000. It cuts off at $160,000. For those who are married and filing jointly, the credit begins to phase out if you have an income of $90,000. There’s no credit if your income is $180,000 or more.
Impact on Federal Loans
Make withdrawals strategically to minimize your total borrowing. There are limits to the amount you can borrow via federal loans each year ($5,500 in your first year; $6,500 in your second year; and $7,500 after that). If you think your total borrowing will exceed one year’s loan limit, you might make smaller 529 withdrawals each year in order to spread out your federal loans to help avoid private loans.
If You Take Too Much Money
Some people take a 529 distribution only to discover that their student doesn’t have enough qualified education expenses this year. You can either prepay next year’s expenses in this calendar year, or roll over the excess into another 529 account (within 60 days of withdrawing the funds). Keep in mind that rollovers are limited to one every 12 months.