How to Tap into Your 529 College Savings Plan

It’s probably hard to believe, but that little bundle of joy you took home from the hospital is now busy packing to move into their first dorm room. Opening that Section 529 college savings plan all those years ago may also feel like yesterday, but you’ll be glad that you did.

Now that your child (aka, the plan beneficiary) is ready to go to college, the bills will follow their journey through school. Remember, you diligently saved to prepare for this moment and now the account is fully funded and ready to go. Which expenses should you pay using the 529 account funds? How do you go about taking a distribution (making a withdrawal) from the 529 plan? This article will help you make an otherwise highly emotional transition to “parent of a college student” as stress-free as possible (at least the financial aspects).

What can 529 plan assets cover?

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). There are five main categories that constitute qualified expenses, including:¹

1. Tuition, mandatory fees, required books, supplies and equipment
2. Room and board
3. Computers and internet access
4. Special needs services, if the plan beneficiary is disabled
5. Up to $10,000 for tuition at K-12 schools

Expenses that do not qualify under the 529 plan include insurance payments, gym memberships, cell phones, and transportation to and from school.²

Withdrawals from a 529 plan that are used to cover any of the QHEEs listed above are free from federal and state income taxes.³ You also avoid the dreaded 10% penalty that comes with any distributions that are not used for qualified expenses.

As long as the 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 on where the student lives. If your student lives in a campus-owned dormitory, the amount you may 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 provide details regarding its room-and-board allowance for students living off campus. As long as the room-and-board expenses do not exceed the school’s allowance, 529 funds may be used, but as soon as those expenses exceed the allowance, funds from other sources must be used.⁴

Most states don’t require you to submit proof of QHEEs to their 529 providers when they request distributions. As the owner of the account, you are ultimately responsible for keeping records of expenses paid using the 529 plan assets.⁵ As with charitable and property-tax deductions reported on your income 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.

In terms of scholarships, you are allowed to withdraw from your 529 plan (without a requirement to use it for QHEEs) an amount that’s equal to any scholarships your child received. That money might still be taxable, but the good news is you won’t be required to pay a 10% non-qualified withdrawal penalty on it.⁶ However, before withdrawing money from a 529 plan and paying taxes, consider leaving the money in the 529 plan account. Later, you can change the plan beneficiary (and therefore transfer the remaining funds) to another family member (brother, sister, cousin, etc.).

Distribution logistics

Distributions from a 529 account can be made to the following three people or entities:

1. Account owner
2. Account beneficiary (student)
3. College/university

Typically, you withdraw from the 529 plan, either directly through their website or by asking your Wealth Advisor to distribute the funds. If the distributions will be made to the owner or the student, it’s usually more convenient to get reimbursed for an entire semester’s worth of costs at one time, rather than one-off reimbursements each time an expense is incurred.

Understanding 1099-Qs

IRS Form 1099-Q is a tax document that reports all the withdrawals you make from a 529 plan during the tax year, and will come from the plan administrator.⁷ It’s used when you file your income tax return. Form 1099-Q will report, in three different boxes, the annual distributions from the account, the portion of the distribution coming from earnings on your initial contribution and what you contributed into the 529 plan (i.e., the basis).⁸

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 for obvious reasons. 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 10% penalty. You want to avoid doing this as much as possible because it could set you back financially.

We’re here to help

Making the transition from saving for college to actually paying for college involves a shift in your mindset. You’ll need to understand which expenses are eligible for reimbursement, who should receive the payments, and how your choices may affect your own tax reporting and liability. We strongly encourage you to consult with your Corient Wealth Advisor about the best ways to manage the distribution of 529 plan assets.

¹ https://www.forbes.com/sites/brianboswell/2019/11/04/whats-a-qualified-higher-education-expense/?sh=630e899a2e98
² https://www.fidelity.com/learning-center/personal-finance/college-planning/college-529-spending
³ https://www.investopedia.com/terms/1/529plan.asp
⁴ https://www.forbes.com/sites/brianboswell/2019/11/04/whats-a-qualified-higher-education-expense/?sh=630e899a2e98
⁵ https://www.forbes.com/sites/josephhurley/2016/02/04/dont-make-these-mistakes-when-reporting-529-plan-withdrawals/?sh=1cb287446155
⁶ https://www.fidelity.com/learning-center/personal-finance/college-planning/college-529-spending
⁷ https://turbotax.intuit.com/tax-tips/college-and-education/what-is-irs-form-1099-q/L7MAdcKz5
⁸ https://turbotax.intuit.com/tax-tips/college-and-education/what-is-irs-form-1099-q/L7MAdcKz5

ABOUT THE AUTHOR