Now That It’s Finally Time to Use Your 529 Plan

KEY TAKEAWAYS:

  • Distributions from a 529 plan are tax-free as long as they are used for qualified college expenses such as tuition, room and board, books and computers.
  • Distributions from your 529 plan must be made in the same year as your qualified expenses are incurred in order for your distribution to be considered tax-free.
  • Review your 529 plan account investment allocations to make sure the portfolio risk is appropriate as your children approach college-age and you begin taking distributions.

 

It’s high school graduation season and my family is deep into all of the activities, parties and ceremonies. My daughter, who is my youngest child, just marched through her commencement ceremony. As many of you have experienced, this rite of passage is a time of reflection. Although it is hard to let go of the last 18 years, it is also incredibly exciting to see my daughter take that next step toward college and the challenges and successes of early adulthood that will follow. If you are a parent like me with a college-bound child, there’s the sadness of knowing that your house will be emptier soon—it’s also knowing that the tuition bill will be arriving over this summer. Though I have been through this emotional/financial rite of passage before with my son, it’s always an eye opener when you see just how much college tuition, room and board, books and the other essentials costs.

For those of you who have diligently saved for your child’s education through a 529 college savings plan, you’ve been very wise. Just keep in mind a few very important rules if you want to tap the money you’ve worked so hard to save in a tax-free manner. Distributions from a 529 plan are considered tax-free only if they are used for the following expenses:

  • Payment for tuition and fees.
  • Payment for room and board. If your child is living off campus, you are still allowed to take distributions for room and board as long as the costs don’t exceed the schools estimated cost for room and board.
  • Payment for books and supplies.
  • Payment for school-related special services.
  • Purchase of a computer as long as it is primarily used by the student while attending college.

However, keep in mind the following limitations on your distributions:

  • You cannot take distributions for expenses that are already covered by tax-free education assistance such as scholarships, tuition discounts, Pell Grants and other related reimbursements.
  • You must reduce the reimbursements by any costs used to claim an American Opportunity Tax Credit or Lifetime Learning Credit.
  • Your distributions must be taken in the same year as your child’s education costs are incurred. A distribution made in a following year would be considered a taxable distribution.
  • You cannot take distributions for transportation costs to and from school or for insurance, sports or club activity fees, and many other types of fees that may be charged to your students but are not required as a condition of enrollment.

When taking the distributions from the 529 plan make sure you keep copies of your tuition bills and expense receipts in case you are ever asked for verification by the IRS. This is something I have personally dealt with since my son started college—like many others, he doesn’t report all of his reimbursable expenses. Also, you have the choice of either paying the college directly from your 529 plan or reimbursing yourself for the expenses. It is completely up to you which option you choose and really based on which choice is most convenient.

Finally, review your 529 account investment allocation to make sure the risk tolerance and growth goals are appropriate for your child’s age (i.e. nearness to your planned drawdown period). Many plans have age-based allocations that progressively reduce the risk of the portfolio over time, but is important to do your own review of your allocation to ensure that the funds you have worked so hard to save are well-protected as you begin the distribution process.

YOUR INVESTMENT MATTERS

It has long been said that a college education is an investment in a child’s future. But with tuition rising at three times the rate of inflation and four-years of attendance at many selective schools approaching $250,000, it’s an investment in your own financial and personal wealth future as well. Contact me any time if you or someone close to you has questions about establishing, growing, or drawing down college saving plans.

 

Todd Flynn, CPA, CFP ® is a Principal at Soundmark Wealth Management, LLC. Todd works closely with physicians, business owners, and other high net worth individuals to help them define their financial goals and implement an ongoing financial planning process.