Your kid(s) is(are) headed off to college – congrats Mom and Dad! Before they even meet their professors, you will receive the first of many tuition bills from the university. Thankfully, you’ve been a responsible adult and have accumulated ample savings for this exact expense in a 529 plan. 

But now, you’re done accumulating and need to distribute. Here are a few mistakes you’ll want to avoid: 

Taking too much money. 

529 withdrawals are tax-free to the extent your child incurs qualified education expenses during the year. If you withdraw more than the qualified education expense for the year, the excess is considered a non-qualified distribution. As a result, you or your beneficiary will have to report taxable income and pay a 10% federal penalty tax on the earnings portion of the non-qualified distribution. The principal portion of your 529 withdrawal is not subject to tax or penalty. 

Qualified education expenses include tuition, fees, books, supplies, computers, and related equipment, and the additional expenses of a “special needs” beneficiary. You can also use money from a 529 account to pay student loans. For students who are pursuing a degree on at least a half-time basis, qualified expenses also include a limited amount of room and board. Since January 1, 2018, qualified expenses also include up to $10,000 in tuition expenses at private, public, and religious elementary, middle, and high schools (per year, per beneficiary). 

Here is what is NOT considered a qualified expense: 

• Insurance, sports or club activity fees
• Fees that may be charged to your student but are not required as a condition of enrollment
• Transportation costs
• Room and board costs in excess of the amount the college includes in its “cost of attendance” figures for federal financial aid purposes. If your student is living off-campus, ask the financial aid department for the room and board allowance for students living at home with parents, or living off-campus. If the student is living in campus-owned dormitories, the amount you can include as a qualified expense is the amount the college charges for its room and board. 

What if you discover that you’ve taken too much?

If you are still within the 60-day rollover window, you can take the excess and roll it into a different 529 plan so that amount is no longer treated as a distribution. Just confirm that you have not rolled over that same 529 account within the prior 12 months. If you are outside the 60-day window, but within the same calendar year, you can look to prepay next year’s expenses. If you discover the excess 529 withdrawal after year-end, there’s not much you can do about it.

Taking too little money. 

Unless your student is planning postgraduate education, or you have another potential beneficiary in the family to whom you can change the beneficiary designation, you don’t want to have money left over in your 529 account once your child graduates. At that point, you’ll be left with a 529 account that – used for any other purpose – will incur tax and 10% penalty.

Taking the money in the wrong year.

The withdrawals you take from your 529 account must match up with the payment of qualifying expenses in the same tax year. If you withdraw the 529 money in December for a tuition bill that isn’t paid until January, you risk not having enough qualified education expenses during the year of the 529 withdrawal. Likewise, if you take a distribution in January to pay for expenses from the previous December, that distribution will be a non-qualified distribution. 

You can ensure proper matching by requesting that the distribution from the 529 plan be sent directly to the university. 

Be careful when sending payment directly to the university.

Requesting the payment be sent directly to the college could be a mistake if you are not sure how the college treats the 529 money in its financial aid process. The correct process is for the college to treat the 529 plan money as a payment of the college’s bill. But, colleges often receive checks for outside scholarships won by their students, and they will typically reduce the student’s federal, state, and institutional need-based grants by an equivalent amount, otherwise known as scholarship displacement. 

You would not want the college to view the 529 money the same way it views a scholarship and reduce your child’s financial aid package. The best thing to do is to confirm the university’s policy with respect to funds received directly from a 529 plan. You always have the option to request the distribution be made payable to you or your student. It then becomes your responsibility to pay the college.

Congratulations to you and your college-bound kid and well done accumulating some cash to put toward this expense. The above items are just a few things to keep in mind. Savingforcollege.com provides other great resources. As always, we are here to help you navigate all of these choices.

Enjoy the ride and happy investing.

Marcos