RETIREMENT TIPS: Understanding 529 Plan Distributors

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By ALAN KONDO, CFP CLU

529 College Savings Plans (named after a section of the IRS code) have become familiar with parents and grandparents wanting to help their children and grandchildren save for college. Contributions to 529 plans grow tax-free, and when distributions are made to pay for qualified college expenses, the gains are tax-free as well.

However, there remains a great deal of confusion around which educational expenses qualify for tax-free distribution status — and which do not.¹ In Publication 970, the IRS gives detailed guidance on qualified expenses. Here are a few important points.

What Is Covered

— Tuition and fees are covered in full.

— Room and board, if the student is enrolled at least half-time. But such expense must be not more than the greater of (1) the allowance for room and board, as determined by the school, that was included in the cost of attendance; or (2) the actual amount charged if the student is residing in housing owned or operated by the school.

— Food. If you spend a certain amount for a meal plan, that entire amount can be deducted, even if used for coffee or ice cream and not a full meal. Weekend meals can also be included if the dining halls are not open.

— Books and supplies. Any fees associated with purchasing school textbooks are considered qualified, as are required equipment or supplies such as notebooks and writing tools.

— Computers/laptops, but only if required by the school. If required, Internet fees and PDAs or “smart phones” may also qualify.

— Special-needs services required by special-needs students that are incurred in connection with enrollment or attendance at school.

What Is Not Covered

— Student loans. Interest on or repayment of student loans is not considered a qualified expense by the IRS.

— Insurance, sports or club activity fees, and many other types of fees that may be charged to students but are not required as a condition of enrollment.

— Transportation to and from school.

— Concert tickets or other entertainment costs, unless attendance is requisite to a course or curriculum.

Note that expenses must apply to a qualified college, university, or vocational school for post-secondary educational expenses. Also keep in mind that taxes and a possible 10% penalty will apply to all distributions that are not considered qualified educational expenses by the IRS, so be sure to check first.
When tapping your 529 account, be sure to avoid taking too much or too little.

If you take too much: The excess will be classified as a nonqualified distribution. You or your beneficiary will have to report taxable income and pay a 10% federal penalty tax on the earnings portion of the nonqualified distribution. The principal portion is not subject to tax or penalty.

If you take too little: If your child graduates and does not attend post-graduate school — or if you do not have another child you can change the beneficiary designation to — you’ll be left with a 529 account that, if used for any other purpose, will incur tax and a 10% penalty. If you have a substantial balance left in your 529 account, consider tapping the account at the earliest tax-free opportunity.

Also be sure to coordinate with other family members who may have funded 529 plans for your child to help determine which accounts should be used first.

¹ Investing in 529 plans involves risk, including loss of principal. By investing in a 529 plan outside of the state in which you pay taxes, you may lose the tax benefits offered by that state’s plan. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary.

Before you invest in a 529 plan, request the plan’s official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses, and the risks of investing in a 529 plan, which you should carefully consider before investing. You should also consider whether your home state or your beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s 529 plan. Section 529 plans are not guaranteed by any state or federal agency.

The opinions expressed above are solely those of Kondo Wealth Advisors, LLC, a Registered Investment Advisor in the state of California. Neither Kondo Wealth Advisors, LLC nor its representatives provide legal, tax or accounting advice.

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