Families Make with 529 Plans
common errors to avoid 2 big factors to consider.
Provided by MidAmerica Financial Resources
that start 529 college savings plans have done their “homework” about these
programs. Missteps are made, though, often with the distribution of 529 plan
assets. Here are some of the major gaffes, and the major factors anyone should
think about before enrolling.
Assuming a university will withdraw 529 plan assets for you. When
the time comes, you have to tell the 529 plan that you need the money and
specify the payee. Typically, a 529 program offers you either a check written
out to you, to your student, or a payment made directly from the 529 plan to
the university. There are two big reasons why a check made payable to the
student may be the best option.
*A 529 plan distribution triggers a Form 1099-Q.
You most likely want your student’s name and Social Security number on that
form, not yours. If your student’s name is on the 1099-Q and your student has
qualifying higher education expenses (QHEE) equaling or exceeding the gross
distribution figure for that tax year listed on the form, that whole 529 plan
withdrawal becomes tax-free and the distribution from the 529 doesn’t show up
on the student's Form 1040. If your name is on the 1099-Q, the distribution doesn’t show up on your 1040. Even if your student’s QHEE
equals or exceeds the magic number on the 1099-Q for the tax year, an omission
may trigger an IRS notice to you, and you will have to defend the exclusion.1
*Let’s say you
accidentally overestimate your student’s qualified education expenses, or maybe
parents and grandparents make withdrawals without each other’s knowledge. In
this event, the earnings portion of the distribution is partly or fully
taxable. If the distribution is paid out to you, then the earnings are taxed at
your federal tax rate. If it is made payable to your student, then the earnings
are taxed at his or her federal tax rate, which barring the “kiddie tax” is
presumably just 10-15%.1
Having a payment
made directly the school can lead to a second common mistake.
Inadvertently reducing a student’s financial aid potential. When
a university takes a direct payment from a 529 plan, its financial aid office
may make a dollar-for-dollar adjustment to the need-based aid a student
receives. Often, it is viewed the same as scholarship money.1
Since the IRS bars you from using multiple
education tax benefits to pay for the same education expenses, using
tax-deferred 529 plan earnings to pay for the first semester of college may
disqualify your student for an American Opportunity Credit. You should read up
on the IRS income restrictions on education credits or consult a tax
professional. Paying the first few
thousand dollars in freshman year expenses with funds outside the plan may
allow your student to retain eligibility.2
Mistiming the distributions. It can take up to two weeks to arrange and carry out
a 529 plan distribution; telling a financial aid office that you are using 529
funds to pay tuition just a few days before a tuition deadline is cutting it
Some families withdraw 529 monies during freshman year, which can
conflict with federal tax returns. If a tuition payment is due in January,
withdrawing it in December will create an incongruity between total withdrawals
and expenses. The same will apply if a withdrawal is made in January, but
tuition was due in December.3
Botching the tax break offered to you on
the distribution. To get a tax-free
qualified withdrawal from a 529 plan, the withdrawn funds have to be used for
qualified, college-related expenses. If the distribution isn’t qualified, it
will be considered fully taxable, and you may be hit with a 10% federal penalty
plus state and local income taxes. If you withdraw more plan assets than
necessary, any excess distribution is also nonqualified. Calculating and
withdrawing the "net" qualifying expenses of your student’s college
education could help you avoid this last problem, or alternately, you could
report the excess 529 funds on the student's 1040.3,4,5
Ceasing 529 contributions once a student
enters college. You can keep putting
money into a 529 plan throughout your student’s college years, with the
opportunity for additional tax-deferred growth of those savings.2
Finally, two other factors are worth noting. These
would be a 529 plan’s expenses and deductions.
represent a key reason why families choose in-state 529 plans. Most states that
levy income tax offer 529 programs with deductions or credits for taxpayers. It
varies per state. In Michigan, a married couple can deduct the first $10,000 of
529 contributions annually, which leads to a state tax savings of up to $425.
Some other states offer no deductions.6
Some 529 plans have
different advantages. If your home state’s 529 plan expense ratio exceeds 1%,
consider another state’s plan. (You can find objective rankings of 529 plan
the expenses and fund choices offered by a 529 plan to those of other funds or
investment vehicles found outside the 529 wrapper.
Make no mistake,
529 plans offer great potential advantages for households striving to meet
future college costs. Just remember to
read the fine print, especially as your student’s freshman year draws closer.
Resources may be reached at 618.548.4777 or email@example.com.
An investor should
consider the investment objectives, risks, charges and expenses associated with
529 plans before investing. Most states offer their own 529 programs which may
provide advantages and benefits exclusively for their residents and taxpayers.
The tax implications of a 529 plan should be discussed with a qualified tax
advisor. Investing in a 529 plan
involves risk including the potential loss of principal invested.
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5 - www.529.com/content/benefits.html