You’ve probably heard that phrase used in a lot of different contexts. Military leave, brain power, spending accounts, and a grooved golf swing all come to my mind. Thankfully, that phrase doesn’t capture the flexibility offered by today’s 529 college savings plans.
At our house, we’re on the home stretch of the college savings game. We are using the money we have saved over the years and I’m thankful. With the tuition assistance for my daughter via Texas’ Hazlewood Act and my son’s decision to join the Army, we are contemplating our options in the event we have some money left over.
For years, I’ve championed the benefits of using a 529 to save for college. Now, given my current “withdraw it” state of mind, I thought I’d look at some interesting points related to becoming a spender instead of an accumulator.
You don’t lose it, if you don’t use it. Let’s get this out of the way first. At the end of the day, if you’re done using it for education purposes, you can always withdraw the money from the account, pay income taxes plus an additional 10% tax on the earnings, and do whatever you like with the proceeds. Yes, there’s a little extra sting in the form of that 10% penalty, but it’s a far cry from “losing it.”
Your contributions are tax-free. Above, I mentioned paying taxes on the earnings. However, the part of any withdrawal that represents your contribution to the plan is always tax-free, regardless of how it used. When you make a withdrawal, at tax time you should receive a 1099-Q that breaks down your withdrawal into two parts: earnings and return of your original investment.
Qualified education expenses. For the earnings portion of your withdrawals to be tax-free, they must be made to cover qualified education expenses. What’s included? A lot. Tuition, fees, books, supplies, computers and for beneficiaries attending at least “half-time,” room and board. If you withdraw earnings for non-qualified expenses, it will be subject to income taxes plus the 10% penalty.
You’re not penalized if you get a scholarship or use Veterans’ Benefits. Generally, the earnings on distributions from a 529 up to the amount of the scholarship or benefits used will be subject to income taxes, but not the 10% penalty.
Transfer of beneficiary. One nice feature of a 529 plan is the ability of the account owner to change the beneficiary of the account. For example, if we still have money left in the account when my youngest daughter finishes school we will be able to change the beneficiary to another of our children or even grandchildren. There are no income tax implications of changing the beneficiary.
You can’t double dip. Claiming the American opportunity or lifetime learning credits may be a great way to reduce what you pay in income taxes. However, you can’t use the same expense you paid with withdrawals from your 529 to qualify for a tax credit. The same rules apply to claiming a tuition and fees deduction: no double dipping.
Use for K-12. As part of the Tax Cuts and Jobs Act, beginning in 2018, up to $10,000 in withdrawals from a 529 for K-12 tuition may be made tax-free. However, be sure to check with your state, as state income tax rules may vary.
At this point, you may be thinking you need a separate degree to navigate all these rules. Be sure to check out IRS Publication 970 for all the details and consult your tax advisor with questions.