Smart Steps to Make the Most of Your 529 Withdrawals
Pretty soon, college acceptance letters will go out and your student will have to make their choice. And you’ll soon see a seemingly endless stream of fees, large and small, for a deposit, tuition, and other fees.
The great thing about 529s are the tax benefits you get. But those benefits can all be undone if you make a mistake in how or when you withdraw funds from the account. Here’s a quick breakdown of what you need to know to avoid those missteps and make the most of your money.
Who can use the 529 funds?
Distributions from a 529 can only be used for the designated beneficiary — otherwise known as the child the account was set up for. So, for example, if you have funds in a sibling’s 529 account that you know they won’t use for some reason, you can’t withdraw them to pay for another child.
The good news: There are ways you can change the beneficiary on an account or transfer funds between family member accounts. Details vary depending on which 529 plan you use. To learn more, read this guide or contact your 529 plan administrator.
What expenses can I pay with 529 funds?
Funds in your child’s 529 can be used for a wide variety of what IRS calls “qualified educational expenses.” That includes expenses such as:
- tuition and fees
- books, supplies and equipment including a computer and software
- room and board for students enrolled at least half-time
- expenses for special needs services.
While there’s a wide range of possible expenses that can be paid with 529 funds, IRS has rules about which fees/expenses count and when. For example, expenses for room and board are allowed, but that doesn’t mean every dollar spent on rent is considered a “qualified” expense. (You didn’t really think IRS would make it that easy, did you?)
The amount you can count as a qualified expense can’t be greater than either the costs charged for your student to live in school-owned housing or the allowance for room and board, as determined by the school for financial aid purposes that was included in the cost of attendance.
What happens if you use 529 distributions to pay for expenses that IRS decides aren’t qualified? You’ll end up paying taxes on that distribution — losing the primary tax benefit of your 529 plan.
Reminder: Everyone’s tax situation is different, and IRS’ rules have some gray areas. So, a cost that might not be a qualified expense for one family potentially could be for another family. If you have a specific question, check with your tax preparer or, if you’re a do-it-yourself type, you can read IRS’ guide on the topic.
Timing is everything
Any withdrawals you make from the 529 must be used for expenses incurred in that calendar year. For most of the year that’s not an issue, but if you have tuition or other bills that come due in January, you want to make sure you use funds you withdrew in January — not funds left over from the prior year.
Similarly, if the end of the year is coming up and you withdrew $10k at the start of the year but haven’t spent it all, make sure you find legitimate ways to use them up. For example, you might be able to pre-pay certain expenses.
Care to guess what happens if you don’t get the timing right? If you said, “I’ll end up paying taxes on the leftover money,” you win the prize.
See also: Budget by the Buck
What if I get a refund on an expense I paid with 529 funds?
Sometimes, you’ll get a partial refund on expenses you’ve paid related to college — maybe your child earned a late-arriving scholarship, or the college recalculated its lab fees. Yay! But, if you paid that expense with funds from the child’s 529, you’ll need to move relatively fast.
That refunded amount has to be redeposited into the 529 within 60 days. If you miss the deadline, it’s considered a non-qualified distribution and you’ll owe taxes on the amount that was refunded.
Of course, most people can’t pay for all of their college expenses through their 529s. So, if you have other college expenses that you didn’t cover with 529 funds you could apply the refunded amount to those instead. (For example, let’s say you paid the tuition bill with 529 funds, but your child’s meal plan was paid out of pocket. If a course fee you paid with 529 funds was refunded, you could count that refunded amount against the meal plan expense.)
Again, every situation is different. Check with a financial advisor, tax preparer, or your 529 plan administrator if you have specific questions.
Another way to make the most of your 529 is to minimize how much you need it by making sure your student as gotten as much free money as possible by pursuing scholarships. For instance, we give out a $2k scholarship you can apply for right now.