Saving into a 529 account for future education expenses is all well and good, but what about when you finally get a kid out of high-school and need to start spending it? How does that work?
Here are some tips, tricks, and important information we like to pass on regarding the functional use of a 529 account.
Qualified Education Expenses
Broad definition. Unlike for other education tax credits and spending, “qualified higher education expenses” under a 529 plan includes room, board, fees & equipment, books, and anything else considered a “reasonable” expense for attending the university.
Covers off-campus living. You can use 529 accounts to pay for living off-campus, including but not necessarily limited to rent, utilities, internet, and groceries – anything that would be part of the package deal you get living on-campus in the dorms. NOTE: What your spending for off-campus has to be LESS THAN or equal to what it would cost to live on campus with a full meal-plan.
No tax reporting. You’ll get a 1099-Q in the mail showing any withdrawal from a 529 account, and your tax-person is supposed to assume that the entire amount was spent on qualified education expenses.
- You DO NOT have to provide them with records proving what the money was spent on (you might later in the event of an IRS audit, but 529 account withdrawals are initially based on the honor system, not reporting).
- It DOES NOT matter what the 1098-T from the university says. That will only show tuition, so your withdrawal amount from the 1099-Q is almost always going to be higher than the 1098-T.
Withdrawals from a 529
Request a check. When you need to make a withdrawal and pay some bills, our recommendation is to pull a lump-sum at the beginning of a semester to cover all projected tuition and room and board costs. Some 529 plans have an online interface where you can request this, and others require a phone call. The check will usually go to the account owner (parent, not the student beneficiary), who can then pass the money to the student. You can make additional withdrawals later if the initial check doesn’t cover everything.
Calendar year. The withdrawal has to happen in the same calendar year as the expense was incurred and paid. You can’t pay the bills out of pocket and reimburse yourself for the prior year once you know the total amount. You also can’t use the money to pay for student loans after graduation.
Keep records. Though you don’t have to prove your withdrawals were spent on qualified expenses in the year you make the withdrawal, you are responsible to prove them in the even of an audit. Keep (or tell your student to keep) all receipts for qualified expenses – just stuff them in an envelope labeled for the correct academic year. NOTE: Depending on your situation, the IRS can go back 3-7 years for an audit, so keep 7 years just in case.
If you either 1) spend your 529 money on non-qualified things and admit this to your tax-person or 2) get audited and can’t prove qualified expenses, then you’ll have to pay a 10% penalty on the earnings only, plus include the earnings as taxable income.