Empty Nest: Kids Out, Tuition Bills In! How to Use your 529 Plan to pay for College

The nest is empty! My youngest headed off for his freshman year of college recently. I find I am alternately a sad emotional mess or an eager beaver, ready for the next chapter of life. My husband and I are still trying to figure out what to do with ourselves. If you have children, perhaps you’ve been there or will be soon. Either way, we can all agree that sending them off to college can be an emotional time. It can also be an expensive time! The kids go out but the education bills come rolling in! We think it makes sense to plan for these bills in advance and as you may know, our favorite college savings tool is the 529 Plan. Perhaps you’ve planned ahead and accumulated a nice sum in a 529 Plan but now that the bills are due, you’re wondering how to actually use these funds efficiently to pay for college.

This Q&A will outline the mechanics of using a 529 Plan and list the expenses that qualify for tax-free treatment. We’ll also cover beneficiary changes, what to do with “left-over” funds and some considerations regarding account ownership. Let’s jump in.

Question: Can I be reimbursed for expenses from my child’s school?

Answer: Yes, if your child’s school is an eligible educational institution. An eligible educational institution is generally any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education.

Question: To whom can checks be made payable when I withdraw money from the 529 Plan?

Answer: The owner, the beneficiary, or the school the beneficiary is attending.

Question: Can checks be sent directly to the school?

Answer: Many schools will accept checks directly from 529 Plans. You may need to set up the 529 plan as a payor. The 529 plan will need to know your child’s student ID and the address where the payment should be sent. Please check with your school to see if this is an option.

Question: How do I request funds?

Answer: If Bragg Financial is the representative on your 529 plan, please contact us and we’ll process the payment. If Bragg Financial is not the representative on your 529 plan, you’ll find the contact information listed on your quarterly 529 statement.

Question: Will I need to maintain documentation for tax purposes?

Answer: Yes. You will need to keep documentation for all expenses reimbursed. Keep the receipts with your tax documents. If you are ever audited, you will need these. For example, if your child lives in housing not provided by the school, you will want to keep a copy of any receipt you want to be reimbursed for. Keep the lease agreement, monthly rental checks, utility bills and grocery receipts. You may want your child to use one specific credit card to pay for utilities and food. This should help you with your documentation.

Each year you will reconcile reimbursement receipts with school expenses on your tax return. The college will send you Form 1098-T which lists amounts for tuition and room and board. Your 529 college savings plan administrator will send you Form 1099-Q listing all distributions from the 529 plan for the tax year. Your distributions most likely will be greater than what is listed on the 1098-T because of the additional expenses you paid (see below).

Question: Which expenses qualify for tax-free reimbursement?

Answer:

1. Tuition and Fees
2. Room and Board.
   If your student lives off campus, you can deduct the off-campus living costs (rent, utilities, and food) provided they do not exceed the greater of the following two amounts:
   1. The allowance for room and board included in the school’s cost of attendance for federal financial aid calculations; or
   2. The actual amount charged if the student is living in housing operated by the school.
3. Textbooks and required reading for the course
4. Computers, related equipment, and internet fees

Question: How important is the timing of my withdrawals from the 529 Plan?

Answer: Very Important. You must submit your reimbursement request within the same CALENDAR year as the payment you made for the qualified expenses. For example, if you pay for spring 2017 tuition in November 2016, you must be reimbursed in 2016—the year you paid the expense.

Question: What should I do with my remaining unused 529 balance?

Answer:

1. Funds withdrawn for non-qualified expenses
   Money withdrawn from a 529 plan comes out of the plan pro rata. This means that when you make the withdrawal, some of the money will be a return of the money you put in the account (basis) and the rest will be earnings. If you make a withdrawal for non-qualified expenses, the earnings will be included in your taxable income and in addition, you will most likely owe a 10% penalty on the earnings. Withdrawals of basis are tax and penalty free.
2. Scholarships
   If your child receives a scholarship, you can withdraw the amount of the current year scholarship out of the account, during that same taxable year, penalty free. The earnings portion will be taxed when you withdraw this money. Because you are pulling out an amount equal to the scholarship, you will not owe the 10% penalty. Attendance at a US Military Academy is treated as a scholarship for purposes of the 10% penalty.
3. Graduate School or Another Post-secondary Institution
   Excess funds can be used by the beneficiary in graduate school to pay the same qualified expenses paid in college. Most 529 plans will allow you to keep the account open for many years. Monies can be used later in life if the beneficiary decides to go back to school. Please consult your plan.
4. Change the Beneficiary
   The owner can change the beneficiary to a qualified family member. Qualified family members typically include siblings, parents, spouses, aunts, uncles, cousins, etc.

Question: What are best practices regarding the ownership of the 529 Account?

Answer:

1. Student
   We do not suggest the beneficiary be the owner of the account because the student then controls the money. In many cases, this is a significant sum to put in the hands of your child at a relatively young age. Another consideration is that student-owned accounts are counted heavily towards the expected “family contribution” when schools are determining how much you can afford to pay.
2. Parent or Grandparent 
   Parent or grandparent-owned accounts are the most common registration. This allows the parent or grandparent to control the funds throughout the education process. Please note that both parent-owned and grandparent-owned accounts may also impact a student’s ability to qualify for financial aid.

A lot to absorb? We know. It seems complex but once you get in the groove, you’ll be fine. And importantly, it’s worth the trouble! The tax savings (you completely avoid paying taxes on the earnings when distributions are made for qualified education expenses) can be significant depending on your investment experience over the life of the account. And finally, before you know it, poof, the money will be gone and the kids will be all grown up and starting their own 529 plans.

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.