QUALIFIED EXPENSES FOR 529 PLANS

FUNDING COLLEGE

Assuming legislation doesn’t make it free or highly discounted in the future, college is one of the largest expenses a family will face. The average 2019-2020 academic year tuition and fees for in-state students attending a Florida public college or university is $3,894—that average bumps up to $17,680 for private colleges.[i] This doesn’t include other living expenses like room and board, textbooks, and extracurriculars. While the range of tuition is wide and many people aren’t certain where their student will end up, it never hurts to start planning in advance.

THE 529 PLAN: A BRIEF OVERVIEW

Section 529 plans, also known as qualified tuition programs (QTPs), are a useful and common college savings tool that offer tax-free withdrawals for qualified expenses. There are two types of 529 plans: prepaid tuition plans and college savings plans. 529 accounts can be opened and funded as soon as a child is born. Each individual interested in funding a student’s education can contribute up to $15,000 per beneficiary each year (any amount beyond this limit is a taxable gift). For those with the resources, another option is to “superfund” a 529 in a single year with up to $75,000 if an individual or $150,000 if a couple. This strategy uses the federal gift-tax exclusion for the next five years, but it gives the funds extra time to grow. Within 529s, owners can choose investment programs that meet their time horizon and growth needs. If withdrawals are used for qualifying expenses, the earnings are not taxable. Nonqualified withdrawals, however, are taxed and subject to a 10% penalty.

That being said, what expenses are qualified? And what happens if the beneficiary receives enough scholarships to pay for college without using the 529, or decides not to go to college at all? The last thing a parent who is already paying significant amounts for college wants to do is incur a 10% penalty on nonqualified withdrawals. Fortunately, 529s offer many different options.

QUALIFIED EXPENSES

TUITION

The first qualified—and most obvious—expense that comes to mind is tuition. You can use a 529 to pay tuition as well as enrollment and other types of fees. Best of all, 529s can pay the tuition expenses for four-year universities, two-year colleges, trade schools, or certain international schools. As long as the institution is eligible for the Education Department’s federal student aid program, it can be covered by a 529 plan.

TEXTBOOKS

There is nothing quite like the sticker shock students experience when they purchase their course textbooks. Depending on the class, this can mean anywhere from a few dollars for a used paperback all the way up to hundreds of dollars for a textbook and software combo—my single-most expensive college semester for textbooks alone lightened my wallet by $900. Happily, 529s can pay for class-required textbooks. Depending on the semester, that can be a hefty chunk!

ROOM AND BOARD

Tuition might be covered by grants and scholarships, but sometimes room and board are not. The funds from a 529 can cover on-campus housing or up to the approved cost of on-campus housing if your student decides to live off-site, as long as he or she is a full-time student.

MEAL PLANS

While free food can probably be found at any given point in time on a college campus, your student will still need regular sustenance for those long nights of studying (and maybe a little partying). On-campus meal plans are a qualifying expense payable by 529 plans, while the qualifications for off-campus food expenses are based on the on-campus allowance for room and board.

COLLEGE-REQUIRED EQUIPMENT

Need a new computer and software for a graphic design major? Internet not part of the apartment package? Have to order that special lab software for chemistry class? 529s can cover computers, internet access, and other tools needed for college. Be mindful that these tools must be used primarily for college as required equipment, and each school will set an allowable limit on these expenses for each academic year.

SPECIAL NEEDS

If your student has a particular disability, a 529 can help cover special equipment and services, such as sign language or note-taking, if needed to attend a college or university. It may also cover the cost of transportation, otherwise a nonqualified expense, if necessary.

GRADUATE SCHOOL AND CONTINUING EDUCATION

The undergraduate years might be fully covered by scholarships, but is your student considering medical or law school or going after his or her Masters? Certain programs carry a significant price tag, but if you still have funds in a 529, they can be applied to graduate school and even continuing education credits, such as certificate programs or classes required to maintain a designation.

OTHER SCHOOLING

A lesser-known aspect of 529 plans is that they are not restricted to college. The Tax Cuts and Jobs Act of 2017 permitted the use of 529 plan funds for elementary or secondary school (K-12) tuition and fees, up to $10,000 per year. A 529 plan can also cover registered apprenticeship program expenses, such as fees, books, and equipment.

STUDENT LOANS

The SECURE Act, passed in December 2019, now permits withdrawals of up to $10,000 from a 529 plan to pay down student loans without penalty. This is a lifetime limit for the beneficiary—an additional $10,000 can be used to pay down the student loans of each of the beneficiary’s siblings.

 WHAT IF MY STUDENT GETS A SCHOLARSHIP?

Whether you have funds saved for college or not, scholarships are something to celebrate! There are thousands of merit-based scholarships available to apply to all through middle school, high school, and college, both through private and public organizations. Florida, for example, offers its Bright Futures scholarship program for high school graduates that meet certain academic and service-related requirements. Did your student get one or many scholarships? Fear not—you have options with your 529 funds.

WITHDRAW SCHOLARSHIP-EQUIVALENT FUNDS

Typically, if you withdraw funds from a 529 to use for nonqualified expenses, that amount is taxable to income and subject to a 10% penalty. If you don’t suspect you’ll need the 529 funds in addition to the scholarship money, in some circumstances you can withdraw the 529 money for reasons other than education without penalty. Nonqualified withdrawals up to the amount of the tax-free scholarship(s) can be taken without a penalty. You’ll still pay income taxes on the earnings, but those earnings are simply treated in a similar way to your basic savings account. Without guidance from the IRS or Congress on the timing of this scholarship distribution, there is some disagreement among experts on whether or not the money must be taken out in the same calendar year when the scholarship paid for college expenses. Be sure to consult a tax expert if you plan to use this strategy.

CHANGE THE BENEFICIARY

Just because one student doesn’t need the money for school doesn’t mean another student in the family can’t benefit. You can change the designated beneficiary of a 529 plan to another member of the original beneficiary’s family without creating a taxable event. You can even set yourself up as the beneficiary. If there are still funds remaining in the original 529, you are also able to roll them over into an existing 529 plan of another child without taxation or penalty. None of these actions are taxable events or subject to the 10% penalty.

Other exceptions to the penalty are if your student attends a U.S. Military Academy or dies or becomes disabled. In these cases, the earnings included in any withdrawals are taxable as income, but are exempt from the 10% penalty.

OTHER CONSIDERATIONS

In many cases, 529 plans will not greatly affect a student’s eligibility for need-based financial aid, as they are considered assets of the parent(s). Nonetheless, be sure to consult directly with your student’s college and the state to determine if they have any protocols about 529s that might affect institution- or state-based aid. Keep records of scholarships received and all expenses, as you will have to report to the IRS. Also note that your claimed expenses cannot exceed your student’s qualified higher education expenses, adjusted by deducting tax-free education assistance (Pell grants, tax-free scholarships, etc.) and any costs used to claim an American Opportunity Tax Credit or Lifetime Learning Credit on your taxes.

Earnings are a part of every withdrawal from a 529, even if you are withdrawing less than was contributed to the plan. If you’re taking a nonqualified distribution, keep in mind that part of it will not only be taxed, but penalized as well.

WHAT’S NOT QUALIFIED

Transportation is not a covered expense (except as necessary for college attendance by a student with special needs). Nor are health care or insurance, pre-enrollment expenses, or extracurricular activities and dues (including for sororities and fraternities). College test prep and entrance exam fees also do not qualify.

Planning and coordinating 529 contributions and withdrawals is key to maximizing the benefits of a 529 plan. Reach out to the team here at Day Hagan if you’re interested in planning for college for your child, grandchild, or other relative. It’s time to strategize for success. It’s time to talk to Day Hagan.

Natalie Brown, CFP®
Director of Client Services
Day Hagan Private Wealth

—Written 2.26.2021.

Print PDF Copy of the Article: Day Hagan Private Wealth Insights: Qualified Expenses For 529 Plans (pdf)

[I] According to College Tuition Compare, https://www.collegetuitioncompare.com/compare/tables/?state=FL&type=public.

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