Are you a parent who is thinking about how to pay for your children’s college? Should you consider a 529 plan? Named after Internal Revenue Code Section 529, a 529 plan provides an opportunity to save for college in a tax-advantaged way. But caution needs to be exercised, since tax advantages disappear if the savings aren’t used to pay qualified education expenses (QEEs).
The best resource is IRS Publication 970 (tinyurl.com/u5f34pdc), which gives extensive details about qualified tuition programs, aka 529 plans. It describes QEEs as “expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution.” A subset of QEEs, qualified higher education expenses (QHEEs), are “related to enrollment or attendance at an eligible postsecondary school.”
A perhaps friendlier resource is a Fidelity article, “How to spend from a 529 college plan,” at tinyurl.com/n2rbx7s. Fidelity, one of the world’s largest asset managers, is the program manager of the Connecticut 529 program called CHET (Connecticut Higher Education Trust).
I wish this could be easier, but spending can be a bit complicated. The key is knowing how to avoid a tax or a penalty, and keeping receipts.
According to Fidelity, the following expenses would qualify, but there are limits: tuition and related fees; books and supplies; computers and related equipment; room and board; and repayment of student loans. The limits on room and board, for example, have to do with whether the child is enrolled half the time or more, whether the amount is “included in the school’s cost of attendance for federal financial aid calculations” and what is “the actual amount charged if the student is living in housing operated by the educational institution.”
If your child is planning to live off campus, you need to go a little further. If the housing is “not owned or operated by the college, you can't claim expenses in excess of the school's estimates for room and board for attendance there,” according to Fidelity. That means that some homework is involved: Parents will need to find out the cost of room and board from the college’s financial aid office in advance.
As to books, only those that are required reading for the courses count. As to computers, as you might guess, “Computer software for sports, games or hobbies would be excluded unless the software is predominantly educational in nature,” according to Fidelity.
Bottom line: Keep track of QHEEs separately from other expenses. Keep a copy of published costs for room and board, etc., if your children are living off campus. Keep any documentation that will justify the expenditure as a QHEE.
When it comes to tax reporting, Rita Assaf, vice president of Retirement and College Leadership at Fidelity, explained that 529 account owners “receive a yearly 1099-Q form when they’ve taken a distribution from their account and must report that spending to the IRS in their annual taxes.”
She emphasized the necessity of keeping records and receipts to document that the money was spent on qualified educational expenses for the beneficiary.
The purpose of holding on to the receipts is to justify expenses if challenged by the IRS. As the Fidelity article points out, “If your withdrawals are higher than your QHEE, then taxes, and potentially a penalty, will be due on earnings that exceed your qualified expenses.”
The timing of your withdrawals is also important as they relate to a particular tax year. As Fidelity notes, “It’s important that the withdrawals you take from your 529 savings account match the payment of qualifying expenses in the same tax year.” Although that seems like a simple concept, delays resulting from issues like processing payments out of a 529 account or by the school, or payments being delayed in the mail, could cause issues. One solution for avoiding delays: Make the payments electronically (something colleges often prefer) from a bank or brokerage account, then reimburse yourself from the 529 account.
Next week, let’s talk about additional college resources.
Julie Jason, JD, LLM, a personal money manager (Jackson, Grant Investment Advisers Inc. of Stamford, Connecticut) and award-winning author, welcomes your questions/comments (firstname.lastname@example.org). Please visit www.juliejason.com.
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