Over the years, as the kids and grandkids come into their college years, there seems to be a lot of misunderstanding as to the rules stipulating 529 distributions. Properly executed distributions are tax-free. It’s a great vehicle. In Publication 970, the IRS gives detailed guidance on qualified expenses. Here are a few important points:
• Tuition and fees are covered in full.
• Room and board, if the student is enrolled at least half time. But such expense must be not more than the greater of (1) the allowance for room and board, as determined by the school, that was included in the cost of attendance; or (2) the actual amount charged if the student is residing in housing owned or operated by the school.
• Food. If you spend a certain amount for a meal plan, that entire amount can be deducted, even if used for coffee or ice cream and not a full meal. Weekend meals also can be included if the dining halls are not open.
• Books and supplies. Any fees associated with buying school textbooks are considered qualified, as are required equipment or supplies such as notebooks and writing tools.
• Computers/laptops, but only if required by the school. If required, Internet fees and PDAs or smartphones also may qualify.
• Special-needs services required by special-needs students that are incurred in connection with enrollment or attendance at school.
What’s not covered:
• Student loans. Interest on or repayment of student loans is not considered a qualified expense by the IRS.
• Insurance, sports or club activity fees, and many other types of fees that may be charged to students but are not required as a condition of enrollment.
• Transportation to and from school.
• Concert tickets or other entertainment costs, unless attendance is requisite to a course or curriculum.
Note that expenses must apply to a qualified college, university, or vocational school for post-secondary educational expenses. Also keep in mind that taxes and a possible 10 percent penalty will apply to all distributions that are not considered qualified educational expenses by the IRS, so be sure to check first.
When tapping your 529 account, be sure to avoid taking too much or too little.
If you take too much: The excess will be classified as a nonqualified distribution. You or your beneficiary will have to report taxable income and pay a 10 percent federal penalty tax on the earnings portion of the nonqualified distribution. The principal portion is not subject to tax or penalty.
If you take too little: If your child graduates and does not attend post-graduate school – or if you do not have another child you can change the beneficiary designation to – you’ll be left with a 529 account that, if used for any other purpose, will incur tax and a 10 percent penalty. If you have a substantial balance left in your 529 account, consider tapping the account at the earliest tax-free opportunity – usually the next generation. It’s a great legacy asset that can last for generations.
Also be sure to coordinate with other family members who may have funded 529 plans for your child to help determine which accounts should be used first. Because a lot of my clients are older, I have lots of grandparents funding for grandkids. I like to use the 529 as a financial education tool between generations. I often have family meetings with several generations, and this tool goes a long way in teaching future generations the importance of coordinating an overall financial plan with purpose.
• Timothy J. Dooley, CFP, is president of Comprehensive Retirement Resources Inc., an independent firm at 201 N. Draper Road, McHenry. Reach him at 815-578-42170.