If you’ve spent years saving for college in a 529, you deserve a hearty congratulations for a job well done. You also want to make sure you don’t trip up in the home stretch … when it’s time to draw on those funds to pay the tab.
With that in mind, here are some helpful tips for tapping your 529 account:
Decide who gets the money
Most 529 plans allow you to direct distributions to yourself, to the account beneficiary or to the college. Some plans allow 529 monies to be directed to other parties as well, perhaps the school bookstore or an off-campus apartment building.
Sending the distribution directly to the school can be advantageous in that it serves as documentation for a qualified withdrawal. You should confirm how your school treats 529 money, however. If the college views it the same as outside scholarships, it may reduce your child’s financial aid by that amount.
If you choose to have the money sent to you or your child, then you are responsible for paying the school (and for the all-important recordkeeping). Also consider that having the money sent to the student means the 529 earnings are reportable on his or her tax return vs. your own. Speak with your tax advisor about the potential implications of this.
Keep good records
If you have 529 monies sent to yourself or your child (via an ACH deposit to your bank account or by printed check), be sure to keep diligent records. Withdrawals from your 529 account are tax free—as long as the monies are used for qualified education expenses. If you withdraw more than the total eligible expenses in a given year, you are required to pay ordinary income tax and a 10% federal penalty tax on the earnings portion of any non-qualified distribution.
Know what qualifies
Many qualified education expenses are obvious: tuition and fees, on-campus housing, and the cost of books, supplies and equipment (including technology) required for attendance at your child’s school. It’s some of the less obvious items that can trip parents up. For example, transportation costs, insurance, sports and activity fees, parking and library fines, are not among the qualified expenses. Likewise, student loans cannot be repaid with 529 funds. Also note that off-campus housing should not far exceed the school’s dorm costs. Check the school’s “cost of attendance” breakdown to determine your “cap” on room and board expenses. Generally speaking, that off-campus apartment will need to be priced similarly to the published on-campus room and board cost to qualify. Anything higher will likely need to be paid outside the 529.
Watch the calendar
You don’t have to wait for the tuition bill to come to withdraw your 529 monies. In fact, processing can take time at both ends of the transaction (from your bank to the school’s bursar’s office), so it makes sense to plan ahead. In doing so, know that the IRS requires that withdrawals from your 529 account match up with the payment of qualified expenses in the same tax year. In other words, don’t withdraw money this year that you plan to deploy toward college expenses next year.
Generally speaking, tuition for fall semesters is due in July or August; spring tuition in December or January. Be particularly careful with a late-year withdrawal. A December 2016 withdrawal may be used for the spring 2017 semester, but the payment must be made in December.
Also consider that if you have over-withdrawn from your account in a given year, you may be able to increase the current year’s qualified expenses by pre-paying the school for next year.
If your child is the beneficiary of multiple accounts, some coordination of withdrawals is in order. For example, where there’s a grandparent-owned account, it can make sense to spend the parents’ money first and the grandparents’ money last. That’s because funds from a grandparent-owned 529 count as income to the student and are reportable on the financial aid application, potentially reducing the amount of future aid. For this reason, some students opt to use the assets held in a grandparent-owned 529 in the final year of college since they will not be filing a federal financial aid application the following year.
Check your risk tolerance … and your investments
The investments you chose when your child was five and college was 13 years away are very likely not the investments you should hold in your 529 account now. In the early years, you were seeking growth of your assets and had sufficient time to weather financial market volatility. As the tuition bill comes due, you have a much lower tolerance for losses. Check that your account is not heavy on very risky assets. Note that if your account is invested in an age-based strategy, the investments are automatically geared to grow more conservative as the college years approach.
Ultimately, there are a number of ways you may be able to optimize your 529 account—and avoid potential pitfalls. Consult with your financial and tax advisors to determine how to make the best use of your hard-saved dollars.
Rob Kron, Managing Director, is the head of Investment and Retirement Education for BlackRock’s U.S. Wealth Advisory group. He provides practical information on topics that are important to every saver and investor of every age. He is a regular contributor to The Blog.