Congratulations! You’ve already set up a 529 college plan for your son, daughter, or grandchild. That is a smart move that can potentially save you thousands of dollars in taxes and start your student down the path to graduation day. But do you know how to unlock the most value from your 529 plan? Here are five tips to maximize your 529 plan dealing with real world complications, including COVID-19, confronting many future grads and their parents.
As a parent and CERTIFIED FINANCIAL PLANNER™ professional, I can attest that a 529 plan is about as close as you can get to the perfect financial planning tool.
For most people, it’s one of the best ways to save for higher-education expenses. It’s cost-effective, easy to implement, and permits tax-free growth of your funds when used to cover qualified educational expenses.
But there are some tips and tricks to maximizing the benefits of your 529 plan. In this article, I’ll share with you a few pointers I’ve picked up over the past 20-plus years using 529 college plans for my own kids as well as for clients and their families. We’ll cover five tips here to maximize your 529 plan and save the next five for a later article.
Tip #1: The beneficiary switch
529 college savings plans are extremely flexible. One of the best features is that you can easily move money from one beneficiary to another; for example, between siblings, or change beneficiaries on a specific account. As background, a 529 plan has only one account holder, usually the parent or grandparent, and one beneficiary, typically the child or grandchild.
Here’s a real-life example. I funded my two kids’ 529 accounts with equal amounts. As most parents know, however, kids can be as different as night and day. My daughter pursued an engineering degree at an excellent, but pricey, private university. My son enrolled in a very reasonable state university. She needed more money, he needed less. When my daughter didn’t have enough money to pay for an unexpected fifth year of engineering studies to graduate, I asked the 529 plan to transfer money from my son’s account to hers. Under 529 rules, you can transfer funds tax-free to another qualifying family member, or change beneficiaries to name another family member, upon request. (Transfers or rollovers between accounts involving the same beneficiary are slightly more restricted.) Who is a qualifying family member? It’s a very expansive list ranging from siblings to nieces, nephews and cousins, and even parents who may have a desire to go back to school.
Tip #2: The COVID-19 refund
COVID-19 has altered norms around education as many colleges and universities close their campuses and switch to online learning. In an unfortunate sign of the times, your college student may have received a refund for tuition, fees, room and board, or other qualified higher education expenses due to COVID-19. Not to worry—529 plans are flexible in responding to today’s changing circumstances.
If you originally withdrew funds from your student’s 529 account to pay those expenses, you can deposit the refund back to the 529 account so your funds can keep growing tax-free.
To put the funds back into the account, your recontributions:
- Must not exceed the amount refunded.
- Must be deposited into a 529 account for the same beneficiary.
- Must occur within 60 days of the refund date.
Your 529 plan sponsor can give you specific directions on how to return the funds. If you do not recontribute the funds to the 529 account, or otherwise use them for qualified expenses, the refund will count as a non-qualified withdrawal potentially subject to tax and penalties.
In another COVID-related development, if your college student incurs remote learning expenses, you can still use 529 funds as long as your student is enrolled in an eligible educational institution. In addition to the normal tuition and fees, eligible higher education expenses for remote learning include computers, software, related equipment, internet access, as well as room-and-board costs in select circumstances. Contact your college or 529 plan sponsor with questions about your specific situation.
Tip #3: The off-campus room-and-board calculation
You probably know that 529 funds can be used to pay for tuition, fees, books, computers and other required technology, and on-campus room and board. But what if your student moves off-campus? Not to worry. You can use 529 funds to reimburse your student for off-campus rent and related expenses, as long as the student is enrolled at least half-time at the educational institution. Less than that, and room and board no longer qualify as a covered 529 expense.
Second, ask your student to keep a record of expenses. I have my son total his expenses on an Excel worksheet and send it to me every quarter. That way, we have a written record for tax purposes and can keep track of what expenses have already been reimbursed. The total may include rent, food, utilities and other expenses that would normally be covered as room and board if your student lived on-campus.
Third, reimbursable expenses cannot exceed the room-and-board costs as calculated by the school. You can usually find that amount by searching online for the college’s cost of attendance, or by calling the financial office.
Tip #4: The $10,000 loan payoff
Running out of 529 money before your student graduates is many parents’ fear, but for some, ending up with money left in the kitty after graduation is almost as bad. There are plenty of great ways to put your leftover 529 funds to good use, which we’ll cover in our next article.
However, one hot-off-the-press way to use 529 money was recently authorized under the SECURE Act. The new provision allows account owners to make tax-free 529 withdrawals of up to $10,000 per beneficiary to pay off college loans. Both federal and private student loans are covered.
This is an ideal way for parents or grandparents to use up leftover 529 funds and help recent grads lighten the student debt load. Just remember that the $10,000 lifetime maximum applies per beneficiary. Siblings are entitled to their own separate $10,000 lifetime limit.
Tip #5: The “Who gets the check” quandary
When you withdraw funds from your 529 plan, you’ll have to choose where the payment is sent. There are three main choices:
- Payable to yourself, as account owner. While this is not usually the best option from a tax perspective as explained below, it may be unavoidable if you’ve already paid the tuition, rent, or other expense and need to reimburse yourself.
- Payable to the beneficiary, or student. Similarly, this would be to reimburse the student for expenses already paid.
- Payable directly to the college, or service provider.
What you’ll learn – usually the hard way – is that your choice impacts the amount of aggravation you’ll face at tax time. The neatest solution, and one that streamlines tax reporting, is to make payments directly to the school.
Reimbursing the student is usually the next best choice. The student will receive Form 1099-Q at year-end reporting distributions made from the 529 plan directly to the school or to the student. Distributions for qualified expenses are of course non-taxable. If there were any non-qualified (taxable) withdrawals, the student will pay any taxes due at his or her presumably lower tax bracket.
You’ll want to avoid having distributions made payable to you. Payments you receive as the account holder (for example, to reimburse you for expenses you already paid) trigger Form 1099-Q and can lead to annoying IRS inquiries. While your good recordkeeping can prove all expenditures were for qualifying educational expenses and are therefore non-taxable, you may need to spend a few hours corresponding with the IRS. And that’s something we would all rather do without.
The versatility of your college 529 plan
529 plans are incredibly versatile and powerful financial tools that can help you get the most mileage out of your college savings. That makes them a hands-down favorite with smart parents and grandparents in every state and walk of life. In an upcoming Wealth Point article, we’ll share with you five more 529 tips, including how to use your 529 plan to supercharge year-end gifting, what to do when your student wants to attend college overseas, how to protect your 529 plan – and your family – even if something happens to you, and what to do if there’s money leftover in your plan.