If you have a child heading off to college this fall, chances are you’re doing the same thing as other parents across the country: Paying the bill.
But withdrawing money from a 529 plan account isn’t always as simple as paying your electric bill. Avoid these traps that could delay your payments or increase your taxes.
Trap 1: Waiting until the last minute to request a withdrawal
In most cases, it’s easy to request a withdrawal. You can call your plan administrator, make a request online, or submit a withdrawal request form. The plan can send withdrawals by check to the account owner, the beneficiary, or the school.
You can transfer the money to yourself or the beneficiary electronically and then make payment to the school.This process generally takes 3–5 business days. That’s why, to ensure you leave enough time for the payments to arrive, it’s best to not wait until the last minute to request your withdrawal.
For NY529s Direct Plan, the plan administrator can send a check to the school. This is a convenient option for families. All you need is the school name, address, and name of the beneficiary/student ID.You should allow 7–10 business days for the check transfer. That’s why, to ensure you leave enough time for the payments to arrive, it’s best to not wait until the last minute to request your withdrawal.
Also, a best practice is to keep receipts, if you’re paying the bill with 529 proceeds.
Trap 2: Not understanding qualified expenses
In order to get the benefit of federal tax-free earnings, you must use your plan money for education-related expenses. If you don’t, you could owe a 10% penalty on the earnings attributed to the withdrawal, as well as federal income taxes.
The good news is that the IRS has a broad definition of qualified education expenses, which include:
- Tuition.
- Fees.
- Books.
- Equipment, including computers, internet access, and computer software.
- Certain room and board expenses.
- Expenses for students with special needs.
Examples of nonqualified education expenses include:
- Student loan payments.
- Travel costs, such as airfare to and from school.
- Sorority and fraternity fees.
- Sports and entertainment costs.
For a full list of qualified education expenses, review IRS Publication 970.
Trap 3: Withdrawing too much each year
You might want to spread out withdrawals over the 4 years of college. That way you’re less likely to withdraw more than your yearly qualified expenses.
When calculating how much you’ll need, make sure you subtract any scholarship or grantmoney from the amount you’re planning to withdraw.
Also, deduct any federal tax credits, like the American Opportunity Tax Credit. This credit is worth $2,500 per year for students who are enrolled at least half-time at an eligible institution. It’s available to families with a modified adjusted gross income that’s $80,000 or less (single) or $160,000 or less (married filing jointly). If you claim the credit, it will reduce the amount of your expenses that are considered qualified.
Learn more about the American Opportunity Tax Credit
FAQs
If you distribute funds from a 529 plan for non-qualified expenses, you'll pay a 10% withdrawal penalty on the earnings portion of the withdrawal, and it will be taxed as income to the beneficiary.
Why shouldn't you use your 529 to pay for college? ›
If you distribute funds from a 529 plan for non-qualified expenses, you'll pay a 10% withdrawal penalty on the earnings portion of the withdrawal, and it will be taxed as income to the beneficiary.
What is the disadvantage of a 529 prepaid tuition plan? ›
The account owner of a 529 plan holds all of the legal power. They can change the beneficiary or liquidate the account (with penalty) at any time. This could be a disadvantage if the owner of your or your child's 529 plan has a change of heart about where to direct their investment.
Are prepaid tuition plans more restrictive than 529 savings plans? ›
Investing in 529 savings plans does come with some limitations and risk. Under IRS rules, you can change your investment mix only two times per year. Unlike prepaid tuition plans, 529 savings plan don't lock in tuition prices, nor does the state back or guarantee the investments.
Can you deduct tuition paid from 529 plan? ›
However, you cannot claim a deduction or credit for expenses that were funded using 529 plan assets. You may be eligible to claim a credit or deduction for the expenses you paid using non-529 assets under the tuition and fees deduction, the American Opportunity Tax Credit or the Lifetime Learning Credit.
What is the grandparent loophole for 529 plans? ›
The grandparent loophole allows grandparents to use a 529 plan to fund a grandchild's education without affecting the student's financial aid eligibility.
What happens to 529 if kid doesn't go to college? ›
If your child decides not to attend college, the funds can be used at any eligible educational institution offering higher education beyond high school, including some overseas, trade or vocational schools eligible to participate in a student aid program run by the U.S. Department of Education.
What happens to 529 when a child turns 18? ›
Once the account owner/beneficiary becomes an adult, they assume control over the 529 plan. With an individual 529 plan, the owner is usually a parent or other adult who saves money on behalf of a chosen beneficiary, typically their child.
Are 529 plans still a good idea? ›
And when you pull the funds out, as long as they're used for qualified higher education expenses, there's no federal income tax on the distribution and often no state income tax. 529 accounts also receive some favorable treatment for financial aid purposes, so they're really a great way to save for college education.
What happens if I don't use my entire 529? ›
The leftover 529 funds can't be used for other types of consumer loans (such as credit cards or personal loans). Roll the leftover 529 funds into a Roth IRA. Also new with the Secure 2.0 Act, you'll be able to roll a portion of the unused 529 funds into a Roth IRA.
Brokerage Accounts
Compared to 529 plans, brokerage accounts offer complete flexibility in investment options. You can diversify your investments across Roth IRAs, HYSAs, mutual funds, stocks, bonds, and more through a single account.
Does 529 plan lose value? ›
It's important to note that your investments can fluctuate, and you can lose money in a 529 plan. Your purchasing power can also decrease due to inflation, which means your investments may not keep up with the cost of college.
Are prepaid tuition plans a good idea? ›
The primary benefit of 529 prepaid tuition plans is they can help you secure future tuition and fees at a lower rate. Not only can this lower your beneficiary's future total costs for their college education, but it may help lessen the need for student loans.
Is eating out a qualified 529 expense? ›
Expenses beyond the books. 529 plans can be used for room and board, off-campus housing and food expenses as long as the student is enrolled at least half-time as defined by the school.
How to use 529 to pay tuition? ›
You can call your plan administrator, make a request online, or submit a withdrawal request form. The plan can send withdrawals by check to the account owner, the beneficiary, or the school. You can transfer the money to yourself or the beneficiary electronically and then make payment to the school.
Can you use a 529 plan to pay for room and board? ›
You can use a 529 plan to pay for qualified room and board expenses like rent, other housing costs, and meal plans. This applies to on-campus and off-campus room and board as long as you incurred the costs while the beneficiary was enrolled at school.
Does 529 hurt chances of financial aid? ›
The value of a 529 plan owned by a dependent student or a parent (529 plans do not allow joint ownership) is considered a parent asset on the FAFSA. Any parental assets, such as a brokerage account, savings account, and other assets, will reduce a student's aid package by up to a maximum of 5.64% of the asset's value.
What are some consequences of not using the 529 plan correctly? ›
You'd simply pay taxes and penalties on your withdrawals. On your federal tax return, this means you will include the earnings that are distributed as ordinary income and would owe a 10% penalty on any investment returns your contributions have generated.
What are the problems with 529 accounts? ›
- Investment choices can be limited. A 529 plan may allow you to invest in a number of different assets, including stock funds, bond funds, and FDIC-protected money market accounts. ...
- Not all 529 plans are the same. ...
- You might easily trigger a penalty. ...
- 529s count against you for federal aid. ...
- Contributions and fees can be high.
Generally, you can't use 529 plan funds to buy a house or pay a mortgage for the student's off-campus housing. Qualified expenses must have been incurred during an academic period when the student was enrolled in or accepted for enrollment in a program leading to a recognized academic credential.
