College 529 Savings Plan Distribution Rules ($ ?s)

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$ ?s

Q: We have saved money for our grandchildren’s college expenses with 529 plans, and now the first is set to begin. What advice do you have as we begin to make distributions from these accounts?

Sincerely,

Coughing Up for College

$ ?s answered by Matthew Illian, CFP®

 

Dear Coughing Up,

Few gifts are more valuable than a college education. 529 plans are beneficial because of their flexibility and the tax savings they offer. These accounts incur no taxes during the growth period, and distributions will be tax free as long as you follow the rules.

To maintain tax-qualified status, all distributions must match qualified higher education expenses (QHEEs), which include the following:

1. Tuition & fees

2. Books and other supplies that are required by the beneficiary (A computer or tablet only count if they are required by the college or program of study)

3. Expenses for special needs students

4. Room and board

Notice that the Tax Man will not let you use a 529 to pay for student loans. Gas mileage to and from class does not count. Neither does a plane ticket. If your student is living in an off-campus penthouse, reimbursing the entire amount of the rent could get you in trouble. Each school has a cost of living equivalent allowance that is the maximum you can include as a qualified expense. Each school’s financial aid office can supply the official allowance.

To stay out of the Tax Man’s wrath, avoid the double dipping that occurs when a federal tuition and fees deduction or education credit (American Opportunity Credit or Lifetime Learning Credit) is claimed on the same expenses that were paid for with dollars from the 529 plan. Check with a tax advisor to see if the taxpayer claiming the student (likely, your children) will qualify for these credits/deductions before paying a bill for tuition and fees with 529 dollars.

When making disbursements, you can have a check cut to yourself, the college, or directly to the beneficiary. Disbursements sent to the owner will generate a 1099-Q tax report in the name of the owner. Disbursements sent to the school or to the beneficiary will generate a 1099-Q made out to the beneficiary. If the 1099-Q is sent to you, keep receipts that match qualified distributions. If not, your beneficiary (or their parents) will need to maintain the tax records. In either case, 1099-Q does not need to be reported on a return unless you distributed an excess amount. Just file them away with your other tax papers.

Leftover money in a 529 plan gives you several options. You can transfer this account to benefit another relative or even your own academic pursuits. Take that European art history class you’ve always wanted to. If you simply want to take the money out, you will only pay tax and penalty on the earnings portion of the 529. After years of tax-free growth in a 529 plan, you are likely not any worse off after tax and penalties than if you had only saved in a taxable account.

If you are just beginning to save for college, you should reference these earlier posts.


 

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Matthew Illian was a Wealth Manager at Marotta Wealth Management from 2007 to 2016. He specialized in small business consulting, college planning, and retirement plans.