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
It's a retirement account, so any money you withdraw to pay college costs will eat into your retirement savings. Taking distributions may also hurt your child's chances for financial aid.
Why shouldn't you use your 529 to pay for college? ›
It's a retirement account, so any money you withdraw to pay college costs will eat into your retirement savings. Taking distributions may also hurt your child's chances for financial aid.
What is the disadvantage of a 529 prepaid tuition plan? ›
Limited availability: Most 529 prepaid tuition plans are only available in a few states, making their availability limited. Further, residency requirements mean that either you or your beneficiary must be a state resident to enroll, restricting access even more. Usage restrictions.
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.
Why don't 97% of people use 529 college savings plans? ›
Part of the reason may be that people are simply unfamiliar with 529 plans, Ms. Hume said. Research conducted for the College Savings Plans Network, a group that promotes the accounts, found that even though they had been around for more than 20 years, only about a third of Americans had heard of them.
What is the problem with 529 college savings plan? ›
The account owner can easily change the beneficiary at any time, or worse, they can take a non-qualified distribution and liquidate the plan. This might become an issue in case of divorce, or if a parent depends on a grandparent or other relative's 529 plan to pay for their child's education.
What is better than a 529 plan? ›
Some 529 alternatives include using a custodial account, Roth IRA or Coverdell Education Savings Account.
Is it risky to have a 529 plan? ›
Like other types of investments, particularly those involving the stock market, your 529 account balance will have its ups and downs. You face a risk that it will be way down right when you need to make withdrawals.
Can I use my child's 529 for myself? ›
You can transfer the funds to another eligible beneficiary, such as another child, a grandchild, yourself or a friend.
If you have a 529 savings plan, you have an advantage: you may withdraw contributions tax-free to pay for “qualified education expenses.” Qualified expenses include not only tuition and fees, but also room and board, books and supplies, computers and software, as well as other materials directly related to school.
Does 529 plan lose value? ›
Assuming your money will grow
Like a 401(k), your money isn't guaranteed to grow, and your plan's performance depends on your investment selection as well as market conditions. It's important to note that your investments can fluctuate, and you can lose money in a 529 plan.
Are prepaid tuition plans a good idea? ›
Advantages of a Prepaid Tuition Plan
The first, and obvious, advantage is that the prepaid tuition plan acts as a hedge against inflation. Taking part in this kind of program guarantees that the money paid will cover the cost of tuition no matter how much it rises over time.
What happens to 529 if a child does not go to college? ›
So, if your child opts out of college, you can name a younger sibling or even a niece or nephew or potentially another relative. And you can even name you or your spouse as the beneficiary if you're interested in furthering your education.
Is eating out a qualified 529 expense? ›
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.
Does 529 hurt chances of financial aid? ›
529 plan distributions receive favorable treatment on the FAFSA. Qualified distributions from a student-owned or parent-owned 529 account to pay for this year's college expenses are not included in the “base-year income” that would reduce college financial aid eligibility.
What are some consequences of not using the 529 plan correctly? ›
What happens if you don't use your 529 plan for any educational purpose at all? Well, you wouldn't forfeit your savings or be stuck with an account balance you can't touch. You'd simply pay taxes and penalties on your withdrawals.
What a 529 Cannot be used for? ›
You cannot use a 529 plan to buy or rent a car, maintain a vehicle, or pay for other travel costs. If you use a 529 distribution to pay for this type of expense, those distributions are considered non-qualified.
What happens if I don't use my entire 529? ›
Other options for using up leftover 529 funds. Transfer the 529 account to a new beneficiary. If your child decides not to go to college or only uses part of the total funds while in school, you can transfer the remaining funds to another family member who is planning to attend college.
