Parenting is marked by a lot of “now what?” moments – baby’s first day home, toddler’s first steps, pre-teen’s first attitude and young adult’s fleeing of the nest. If (after just a blink) your baby is about to head off to college, you may soon be wondering what to do with funds saved to their 529 college savings plan. To help, we’ve asked Mike Diephouse of TIAA, a 529 plan professional consultant of 15 years, a few important questions. Here’s what Mike had to say:
Q: What types of expenses count as qualified higher education expense?
A: 529 plan withdrawals taken to cover qualified higher education expenses are free from both federal and state income tax. Qualified higher education expenses include tuition, books, certain room and board, mandatory fees, computers, required equipment and supplies. Higher education includes any college, university or vocational school that qualifies for federal aid.
Q: Do I need to report plan distributions on my tax return?
A: Yes. You will receive Form 1099Q for any 529 plan withdrawals and will be responsible for reporting this information on your return. We strongly suggest that you keep all receipts related to higher education expenses for your records.
Q: What are the most common ways to take distributions from a 529 plan?
A: There are a few ways to take plan distributions and only the named account owner can make the requests (not the beneficiary). Making direct payments to an educational institution can help simplify your paper trail, but distributions may also be made to the owner or beneficiary, which can be necessary if a deadline is fast approaching. Keeping receipts is even more important when making distributions to the owner or beneficiary. Funds may be disbursed by check or electronic transfer.
Q: What are my options if there is money left over in a plan?
A: There are no age or time restrictions to using 529 funds. If the beneficiary decides to go back to school for an advanced degree, they can use the money then. Other options include changing the beneficiary to an eligible family member of the original beneficiary (even including an owner/parent) or keeping the funds in the plan as a family legacy for future generations. There are typically no fees or tax implications of changing a beneficiary, but some plans do restrict how often it can be done. Lastly, there is always the option to take the funds as a non-qualified withdrawal. Non-qualified distributions of earnings will be subject to ordinary income tax plus a 10% federal penalty and potentially a state penalty (amount varies by state). All 529 plan distributions (qualified or non-qualified) are considered principal (contributions) and earnings (growth) on a pro-rata basis. Again, on non-qualified distributions, only the earnings portion will be subject to tax and penalty.
Q: What if my child/beneficiary gets a scholarship?
A: Distributions taken up to scholarship amounts are considered non-qualified but receive an exception to federal (and state) tax penalties. Other exceptions include attending a military academy, death and disability. Ordinary income tax will still apply on earnings, however. To avoid taxation all together, you may still consider the beneficiary change or legacy options described earlier.
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