You have saved for years and have now arrived at the time at which you need to take distributions from your child’s qualified 529 plan. You remember the tax benefits and reasons for starting the plan in the beginning and start taking your tax-free deductions, right? Maybe.
Remember there are rules associated with these distributions. Expenses which you deem “qualified education expenses” may not be the same as what the Internal Revenue Service deems “qualified”. Always seek the advice of your tax consultant, my outline below may not be specific to your situation and may change with time. With that said, let’s look at what you generally can and can’t do.
What is a 529 Plan?
A 529 plan is a plan established under the internal revenue code to allow taxpayers to establish a college savings plan to grow tax free. In theory, this allows the taxpayer to accumulate more and acts as an incentive to do so. More importantly, it allows the funds to be withdrawn at a future date and the earnings are not taxed. Not taxed I say, as long as the withdrawals are for qualified expenses. There are always caveats and requirements which must be met to qualify. Without getting into detail about these, let’s assume you have met the qualifications for a qualified plan and here you are, wondering what are the rules for a qualified withdrawal.
What Counts as Qualified Education Expenses?
Let’s remember that these expenses need to be for a qualified beneficiary and related to enrollment at an “eligible educational institution” defined as:
“any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution. Certain educational institutions located outside the United States also participate in the U.S. Department of Education’s Federal Student Aid (FSA) programs”.
There are many more definitions and requirements that I don’t want to list here and bury the information you need. If you want the detailed information, visit the IRS site here.
OK, enough with the jargon. Let’s start with the easy “yes they are qualified” category.
- Tuition and fees required by the educational institution. Easy enough, right?
- Books, supplies and equipment required by the educational institution.
Expenses for Room and Board. Wait! … Maybe
Expenses for room and board are a bit tricky. Room and board paid directly to the institution, yes. Off-campus living expenses are considered qualified room and board TO THE EXTENT THEY DO NOT EXCEED THE INSTITUTION’S ROOM AND BOARD COSTS. Check with the educational institution and determine what they use for financial aid purposes as the amount for room and board costs. Your distributions for room and board are qualified to the extent they do not exceed this amount. Room and board includes rent, food, utilities etc. However, remember that the key limitation is what the educational institution estimates room and board costs to be. This is your limit.
What Distributions Do Not Qualify?
Well, these would be those expenses which aren’t included above. Generally, anything you pay directly to the institution is qualified. Off-Campus room and board is qualified to the extent the institution’s cost of room and board is not exceeded. Books, computers, internet access, specialized lab materials and equipment etc. are qualified. Other Items, generally are not. Many misconceptions exist regarding cell phones and other electronic devices, travel, memberships to fitness centers etc. These are generally not qualified. If you really want a detailed explanation, I suggest an e-book such as this to provide you with reference material.
How is all of this Reported?
At year end, you will receive a 1099-Q which will report the distributions from the qualified plan. You or your tax consultant will need to determine the amount of these distributions which may be subject to tax. If your distributions are in excess of what the actual allowable qualified expenses were, then you have an amount which is subject to tax on your tax return. This amount is not treated as capital gains from investments and afforded the lower capital gains rates, but it is reported as other income and taxed and your normal effective tax rate. So, be careful. It is best to either pay the institution directly for related expenses, or at least reimburse yourself as those expenses are incurred. If you over estimate the expenditures and thus the reimbursements, you could very well find yourself with taxable income. It is important to remember that these expenses and the reporting are based on when they occur, not for what period which they relate. For example, If you take a distributions in December 20×7 in anticipation of paying tuition in January 20×8, you could very well have distributions in excess of qualified expenses for year 20×7. My best advice is to keep the distributions in the same year as you pay the expenses. Just remember, you must maintain all receipts and documentation.