529 College Accounts: Spending Smartly
The cost of sending kids to college goes up every year. The average tuition for an in-state public school have risen to over $9100 a year. That doesn’t count room and board, textbooks, or other needs for your student. Setting up a 529 college savings account can help ready you for the expenses of college. But knowing the right way to access this cash isn’t always easy. Fortunately, there are some helpful tips to help avoid some tax penalties when you use your child’s 529 college savings account.
Make a Plan for Tax-free Withdrawals
It’s important to note that you can’t double up on tax breaks for the same costs. With that in mind, planning to withdraw from a 529 college savings account can be done without federal penalties. Avoid these by adding up all of your student’s college-related expenses. Things like tuition, room and board, supplies, books, and any school-related special expenses. Then subtract any additional college aid such as Pell grants, tax-free scholarships, Veteran’s Educational Assistance Program, tax-free employer college benefits, fellowships, or tuition discounts. Next you need to deduct any costs used to claim an American Opportunity Tax Credit or Lifetime Earning Credit.
Know What Expenses Qualify as College Spending
Funds from this type of savings account can ONLY be used to pay for school-related costs. But there are definitely some things to keep in mind when accessing the cash. Tuition and fees are considered necessary costs. But housing can be a little tricky. The costs for room and board cannot be higher than the allowance for room and board included in the school’s costs for federal financial aid. It also cannot be greater than the actual amount charged if the student is living in school-provided housing. Any amount greater than the college’s room and board costs cannot be paid with a 529 account. Checking the exact costs with the school for tuition and room and board will help to eliminate any surprises later on down the road.
Textbooks, computers, and supplies
There are some incidentals which can be covered by a 529 college savings account and others which will incur penalties if used to cover expenses. Textbooks are covered, but only those which are considered required course material. Additional books or resources will not be a qualified expense. Computers are also considered a qualified expense as long as it is used predominantly for educational purposes and the software installed on the computer relegate it as such. Other living expenses used for entertainment, travel, or lifestyle related expenses do not meet the requirements for a tax-free withdrawal.
Be sure to keep copies of receipts for proof, and make purchases of essential and non-essential items separately. Any money taken out that doesn’t cover qualified expenses is taxed as income. This means it could incur a 10% federal tax penalty. The tax penalty can be waived if there are special circumstances such as disability or death of beneficiary. Other special circumstances include the beneficiary receiving scholarship money, veteran’s benefits, or other nontaxable educational assistance which isn’t considered an inheritance or gift.
Decide the Best Way to Withdraw from your 529 College Savings Account
You can pay tuition directly from the 529 college savings account. This helps make record-keeping easier. Make note of the deadlines to pay tuition and how long it takes to transfer money from a 529 college savings account to the school. Sometimes it can take a few days for money to be sent for tuition payments.
Another way to use the funds is to transfer the money to a bank or brokerage account. This gives the convenience of paying tuition and fees electronically. This also makes it easier to divide up money for both large and small qualified expenses.
When taking money out of the 529 account, it is important to remember to submit requests for cash in the same calendar year. This can be confused with the academic year, which typically runs from September to May. If your timing is wrong, you could end up owing federal taxes on the withdrawal because it might not be considered a qualified expense.
You can also have the money given directly to your student. While the student will still likely have to report the cash received as income, it is often a far lower tax-bracket and reduces the tax liability. Any tax can also be wiped out by claiming the American Opportunity Tax Credit or the Lifetime Learning Credit.
Avoid Conflicts with Other Tax Credits
There are several federal tax breaks for college costs. Using these tax credits means you won’t be able to use the 529 college savings account. This means you’ll want to plan ahead to decide which is the best bet, tax-wise. If you DO decide to use the federal tax credits, it could impact your student’s ability to qualify for certain types of financial aid. The most common of these federal tax credits include the American Opportunity Tax Credit and the Lifetime Learning Credit. For more information about these tax credits, click here.
Leftover Money in a 529 College Savings Account
Hopefully, you planned everything out perfectly so that there is little (or nothing) left in the 529 college savings account upon graduation. Of course most people can’t know exactly how much tuition and housing will change over the course of a college education. If you find yourself in a position where there is money left in the account there are steps you can take to reduce your tax liability. First, you can allow the money to stay in the account if your student is considering furthering education (think graduate school or Harvard Law or ITT Tech or whatever). You may need to adjust how money is invested in the account to cover the costs. Second, you can change beneficiaries on the account with no additional expense. If your smarty-pants firstborn gets a full ride, you can roll over the 529 college savings plan to one of your other children. You can speak with your financial adviser about the best way to transfer any funds leftover after graduation.
It’s amazing how quickly kids go from being infants until they are heading off to college. It seems like you have all the time in the world to start saving for college, but time has a habit of getting away from a lot of us. Starting a 529 college savings plan can help offset the costs associated with earning a higher education. Using it wisely to avoid tax penalties takes some time and planning. So get planning. Go ahead. Time’s a-wasting.