Important Things to Know About 529 Plan Withdrawals

You know that 529 plans are designed to help you secure funds for higher education. However, the details of plan withdrawals might raise a few questions.

If you aren’t careful, the withdrawals may be taxable (even in years with substantial college costs)! Distributions are tax free if, and only if, they are used to pay Qualified Higher Education Expenses (QHEEs). Qualified withdrawals include tuition, fees, books, computer technology, and Internet fees. Special needs equipment is also a qualified expense. Be cautious! Room and board expenses could be limited, and the student must attend the college at least half time. A 529 plan cannot be used to cover transportation costs or to repay student loans.

If distributions exceed QHEEs, all or part of the withdrawn earnings is taxable. If you withdraw more than the QHEE, the excess is a non-qualified distribution. You or your beneficiary – you can choose who receives the money – will have to report taxable income and pay a 10% federal penalty tax on the earnings portion of the non-qualified distribution. The principal portion is not subject to tax or penalty.

If you find out that you have taken too much money out of your 529 plan, you have a couple of options. First, if you discover the issue within 60 days of the withdrawal, you have the option to roll the excess into another 529 plan if the recipient has not had a rollover within the prior 12 months. Second, if it has been more than 60 days, but within the same calendar year, you can prepay the next years’ expenses which will increase the current year’s QHEE. If you discover the excess at year-end, unfortunately, there isn’t a way to avoid the penalty.

Who does the money in a 529 account belong to? If you are the account owner, and the money in the account initially belonged to you, then YOU call the shots regarding how and when the money is spent. This helps to ensure the money is spent as initially intended, and allows “left-over” money to be transferred to another beneficiary if desired. Be sure to coordinate with others who may have a 529 plan for the same individual to determine whose account should be utilized first.

“Who do I make the check out to?” If not paid directly to the college, the check should be made out to whoever will benefit from the funds. This can be either the beneficiary or the custodian of the plan. You always want to be able to trace where the money went. Needless to say, whoever benefits from the money is also responsible for any taxes.

There are many details to consider regarding withdrawals from a 529 plan. For any questions on 529 plans, we invite you to contact our Financial Advisors.

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