It’s hard to believe, but that little bundle of joy who came home from the hospital what seems like just days ago is now busily packing up to move to his/her first dorm room. You probably also remember opening that Section 529 college savings plan, and it may feel like that was just yesterday, too.
You deliberately saved to prepare for this moment, and now it’s time to begin making 529 withdrawals to pay for college expenses. So which expenses should you pay for using your 529 account? How do you go about taking a distribution (making a withdrawal) fromthe 529 plan? This article hopes to help you make an otherwise emotional transition to “parent of a college student” as stress-free as possible.
What Can a 529 Plan Cover?
In order for distributions from a 529 college savings plan to remain tax- and penalty-free, you must use them to pay for what are known as Qualified Higher Education Expenses (QHEE). QHEEs include tuition, mandatory fees, required books, supplies, and equipment.
As long as the 529 beneficiary/student is at least a half-time student, room and board is also included as a qualified expense. However, there are some restrictions for room-and-board deductions, depending upon where the student lives. If your student lives in campus-owned dormitories, the amount you can include as a QHEE is the amount the school charges for its room and board. However, if the student lives off campus, you’ll need to ask the college’s financial aid department to detail foryou its room-and-board allowance for students living at home with parents, or living elsewhere off campus, as the case may be. That’s the figure upon which you’ll base your 529 room-and-board withdrawals.
Clients often ask us if they need to submit proof of QHEEs to their 529 providers when they request distributions. However, most states don’t require it. As the owner of the account and the taxpayer, you’re ultimately responsible for keeping records of expenses paid for with your 529 plan assets. As with charitable and property-tax deductions reported on your tax forms, you should keep documentation for any expenses you incur, just in case you’re ever audited and the IRS asks for proof of those expenses.
And one note about scholarships: You’re allowed to withdraw from your 529 plan (without being required to use it for QHEEs) an amount equal to any scholarships your child received. That money might still be taxable, but you won’t be required to pay a 10% “non-qualified withdrawal” penalty on it. However, before withdrawing unneeded money from a 529 plan and paying taxes, consider leaving the money as is. Later, you can change the plan beneficiary (and therefore transfer the remaining funds) to another family member of the same generational level (brother, sister, cousin, etc.)
Distributions from a 529 account can be made to the following three people or entities:
- Account owner
- Account beneficiary (student)
Typically, you alert the 529 plan (directly or through your financial advisor) of the amount to be distributed and to whom the payment should be made. If the distributions will be made to the owner or the student, it’s usually most convenient to get reimbursed for an entire semester’s worth of costs at one time, rather than each time an expense is incurred.
Are you familiar with IRS Form 1099? This document reports any interest income, independent contractor income, and/or distributions from IRAs. It’s used when you file your tax return. Similarly, you’ll receive a 1099-Q once a year to show the total distributions you’ve taken from each 529 account you own.
How are distributions from a 529 plan treated for tax purposes? In a nutshell, if the amount of QHEE you actually incurred is more than the distributions you’ve taken from your 529 plan, there’s nothing to report on your tax return. The exception: If these same expenses were used for educational tax credits. To use the distributions for both purposes is considered “double dipping” and isn’t allowed. When you take out more in 529 distributions than you actually incurred in expenses, a portion of the distribution might be taxable and subject to a penalty. You want to avoid doing this as much as possible.
The 1099-Q form is created a little differently, depending on who receives the distributions: The account owner, the beneficiary (student), or the college/university.
Option #1: A check payable to the owner triggers a1099-Q in the owner’s name and social security number. In addition, a box on the Form 1099-Q is checked, indicating that the distributee (recipient of payment) is someone other than the beneficiary. Even if the distribution is tax-free because it was used to cover qualified expenses, the IRS is likely to issue a notice to the account owner when it sees nothing reported on the owner’s 1040 form. The owner must then respond to the IRS to justify excluding the distribution from his/her taxes.
Option #2: A check payable to the beneficiary (student)triggers a 1099-Q in the student’s name and social security number. If the student’s qualifying expenses during the calendar year are equal to or exceed the 1099-Q distribution, the distribution is tax-free and nothing appears on the student’s 1040 tax form.
Option #3: When 529 funds are distributed directly to the college, a1099-Q is not issued. However, some schools treat 529 plan payments the same way they treat outside scholarships. That is, if a student earns a needs-based financial aid package from the college, the school can adjust that award downward on a dollar-for-dollar basis, depending on how much the student receives in corresponding scholarships (or in this case, 529 plan distributions). As such, it’s important to understand the school’s 529 funds receipt policy ahead of time.
By choosing payee options 2 or 3, you may be able to avoid an IRS notice, which requires some additional work. However, you should consult your accountant to see what distribution method he/she recommends based on your personal circumstances.
Making the transition from saving for college to paying for college involves a bit of education on your part. You need to understand which expenses are eligible for reimbursement, who should ideally receive the payments, and how your choices may affect your own tax reporting and liability. We strongly encourage you to consult with your RegentAtlantic Wealth Advisor about the best ways to manage distribution of your 529 plan assets.
Important Disclosure Information
Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This information is not a substitute for personalized advice from RegentAtlantic. This information is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
Please remember that RegentAtlantic does not provide tax advice. Please consult with a tax professional of your choosing prior to implementing any of the strategies discussed in this article.
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.
This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.