As the, “Congratulations! It is with great pleasure that I inform you of your acceptance….” letters come rolling in the first difficult decision is choosing where to go to college. The next tough decision is paying for college. To whom is the check made payable over the next 4 years if you have a 529 plan? Now that money has been saved for college tuition, it’s time to ask this question: how best to distribute the funds?
529 Plans were created under the Small Business Job Protection Act of 1996 to allow taxpayers a tax-advantaged way to save for qualified education expenses for a designated beneficiary. Funds set aside can grow tax-deferred and be withdrawn on a tax-free basis, if you follow the rules! Since 529 Plans haven’t been around long, there is often some confusion as to the underlying requirements that you must adhere to when taking tax-free distributions. Below are some top tips to know before cutting that first check.
Tip #1: Know Which Expenses Are Qualified. Qualified higher education expenses include tuition and fees, books, certain supplies and technology, plus room and board. While tuition, fees and books seem pretty straightforward, know that technology is qualified only if used by the beneficiary while enrolled. Room and board expenses are considered qualified if the student is enrolled as more than a part-time student and the payment for room and board is paid directly to the institution. For students who live off-campus, the budget is set forth by the school and you must pay the landlord directly. Be sure to check limitations requirements and stay within or they may not be considered qualified.
Tip #2: Make Sure Distributions Are Taken in the Same Year a Qualified Expense is Paid. 529 Plan Distributions can be taken at any time during the year and are considered tax-free as long as an equal (or greater) amount of qualifying expenses are incurred in the same year. Your withdrawals and expenses must match during a calendar year, not academic year.
Tip #3: Determine to Whom the Distributions Will Be Made Payable. There are three potential payees to whom the 529 Plan Administrator can make payments: (1) the beneficiary, (2) the school or (3) the account owner. So far, we haven’t come across a 529 Plan Administrator that provides the option of a checkbook or debit card, but perhaps that will change in the future. So, requesting a check either payable to the beneficiary, school or owner of the plan remain your only options.
Tip #4: Keeping Good Records. It’s important to keep clear records of both to whom distributions were made and for what qualified purpose. This is so that you are able to prove the distribution from the 529 Plan was to reimburse the student or owner for a qualified expense, otherwise the withdrawal will be subject to income tax and the 10% penalty associated with non-qualified distributions from a 529 Plan.
Remember to ask the Custodian of the 529 for a complete guide outlining all rules and requirements. Having a complete understanding upfront can help reduce any tax implications later.
