Four Top Tips for 529 Withdrawals
Over the years, you’ve invested in your children’s well being: you’ve grabbed them by the arm before they ran out in front of a car, taught them to brush their teeth each night and morning, and doctored every skinned knee and elbow. But have you thought about investing in their college education?
Parents often seek my advice on creating college savings for their sons and daughters. I’m so glad they asked — a 529 college savings plan is an excellent tool for building and managing funds for their education.
Here are the top four things you need to know about 529 plans and withdrawals.
But first, what is a 529 plan?
A 529 plan is a tax-advantaged college savings plan sponsored by a state, state agency or educational institution. The savings accumulated can be put towards education-related expenses such as tuition, books, and so forth. Withdrawals from college savings plans can generally be used at any college or university.
1. What’s the difference between a qualified and a non-qualified withdrawal?
A qualified withdrawal is one where the 529 funds are used for their intended purpose, thereby avoiding taxes and a 10% penalty. Examples of qualified withdrawals include:
- Tuition and fees
- Computer technology, related equipment, and internet access
- Some room and board expenses, assuming the student is enrolled at least half-time. If the student lives off campus, you can withdraw up to what the school includes in the cost-of-attending figures.
A non-qualified withdrawal is one where the 529 funds are used for an ineligible expense. Non-qualified withdrawals are subject to income tax and may incur additional federal and state tax penalties. Ineligible expenses include things like:
- Transportation costs
- Student loan repayments
- That “must-have” pair of new shoes for graduation
2. Do I need to make 529 payments directly to the school?
Most 529 plans let you choose how to distribute your funds. Check with your 529 provider for specifics, but most allow you to distribute payment to:
- The account owner
- The beneficiary
- The school
Choosing to send your 529 distribution directly to the school may be a simpler option than first depositing the funds into your checking account and then paying the school.
Note: Your 529 plan provider will not keep track of where this money is spent for tax purposes, so make sure to keep all your receipts and bills, in case your tax return is selected for “additional examination.”
3. What if I don’t need my 529 money for college expenses?
Let’s be honest — it’s pretty much impossible to predict the future. So what happens if you don’t need the money you’ve been saving for college expenses?
While none of these exceptions provide a way to avoid paying income tax on the earnings, you can avoid paying the 10% federal tax penalty if one of these situations applies to you:
- The beneficiary dies or becomes disabled.
- The student receives a scholarship, allowing you to withdraw up to the scholarship amount.
- The student decides to attend a service academy like the U.S. Air Force Academy (my glorious alma mater!)
4. My son or daughter received a scholarship? Should I withdraw that amount of money from the 529 plan?
It depends. Remember that most scholarships do not cover every expense. Before you remove money from the 529 and give up its tax-free status, ask yourself these questions:
- Is room and board covered? Is internet covered?
- What about lab fees? What about a laptop or printer?
- Can you use these funds for education costs for another family member — even yourself? Look at the list of eligible beneficiaries before making a change.
- Does your child plan to go to graduate school? If so, you can use 529 funds to pay for that as well.
Using these four withdrawal considerations, you can maximize those hard-earned college savings. And if you’re reading this and thinking, “I haven’t even started yet!” I recommend that you listen to The Money Drill podcast with Josh Andrews to learn about more ways to save up for education.