How to Withdraw Money from a 529 Plan
Carl Lachman, CFP®, MBA
It Just Got Real Real
My son will attend college in a couple of months, and the first semester’s payment for tuition, room, and board is due tomorrow. My 16 years of helping my clients plan for college expenses is now expertise I am drawing on in my own life. It just got “real real.” (It’s a term the kids use these days.)
Saving for College Without Taxes
Putting money into savings for college is often started by parents or grandparents who want to do what they can to help their kids or grandkids afford a college education. The cost can be steep, so anything to stretch dollars in this area is helpful.
One big way to help the dollars to go further is to save with a college savings 529 account, since the money can be invested, grow tax-free, and be withdrawn for certain college expenses without taxes.
Rules for Contributing
When money is contributed to a 529 plan, certain rules must be followed. One can’t contribute more than $15,000 in one year (which is the current annual gift tax exclusion amount).
Actually, that’s not quite true, since one could contribute five years of gift tax exclusions all at once, which is $75,000. But if you do that, then for this year and the next four years, you can’t make any other gifts to the account recipient or any further contributions to their 529 account.
Additional rules for contributing are (1) there are no federal tax deductions for contributions to 529 accounts; (2) only some states allow limited tax deductions for contributions (not California); and ... that's about it. There are not too many rules to get money into a 529 plan, and while a few more do exist, I don’t think most people need to worry about them.
Rules for Distributions
Isn’t it always true? Getting your money back is always harder than giving it away!
In the case of 529 accounts, there are lots and lots of rules to obey when you want to get money out of these tax-advantaged accounts. While none of the advisors at our fee-only financial planning firm knows anyone who has been audited or penalized for distributing 529 money incorrectly, we help our clients carefully follow the rules. And, you should too.
The Easy Way Is Simple
Generally, if you use 529 funds for paying a college directly for a bill they have sent, you are in the clear. Such a bill should include only tuition, housing, meal plans, books, lab fees, college administrative fees, facility use fees, fee fees, etc. (College finance departments seem to be very creative in the fees that are tacked on to college bills.)
All of these costs and fees are OK with the IRS. And, if the bill is paid directly from your 529 plan to the college, the trail is documented and simple to substantiate. However, a college bill might include a couple of not-allowed expenses, so keep reading.
The Next Way Isn’t Very Hard, but Be Careful
You don’t have to pay a college directly from your 529 plan; you can, instead, reimburse yourself when you have paid these approved college expenses.
You must keep detailed records and receipts of the expenses you have paid and when you were reimbursed, but if you don’t get creative with what a “college expense” is, then you should be fine.
The 529 plan usually asks if you are taking the reimbursement for approved college expenses, but it is not their job to ask for substantiation or be the gatekeeper. If there is ever a question about how the funds are used, it is on you, so be careful. And, make sure you reimburse yourself in the same tax year as the expenses.
What Other College Expenses Are Approved? Be Cautious
Certain things that are used only for college by the beneficiary are approved, such as computer hardware, software, and internet access. Also approved are supplies and equipment for classes and services for beneficiaries with special needs or disabilities.
But, you are not allowed to pay off student loans with 529 funds, and travel expenses to and from college are not allowed. Also not allowed is the cost of transportation (car, train, metro, taxi, etc.) at college; medical expenses while in college; health insurance at college, whether required by the college or not; athletic team costs at college; and expenses related to clubs and other activities at the college. (I won’t be able to pay for my son’s college snowboarding club expenses with 529 funds.)
Flexibility with 529 Funds
You do have some flexibility with 529 funds. If you are in the rare situation that you have more money in an account than you need for the beneficiary, you can use the money for a different child, for yourself, for your spouse, or for other grandchildren.
You can also use the money earlier for certain elementary and secondary school expenses, up to $10,000 per year, but be careful of state rules.
In all cases, the 529 funds can only be used with an eligible educational institution. If there is any question about eligibility, you will want to double-check to make sure the school or college is on the Department of Education’s website.
Administrative Steps for the Withdrawal
Every 529 plan is a little different in regard to the steps needed for getting the money out of the account. Some plans allow it to be done simply online after you log in, while others require a phone call or a signed form. You will need to check with your 529 plan for the specific steps they require, and please assume they will need a couple of weeks to get the money paid to the college or to you.
In the case of the 529 plan we use with our clients, if they tell us the amount and the college, we do the rest to get the money out. It is an included service, and we don’t charge extra.
Or, as I found out when I did it for my son’s bill in the last month, our clients can do it themselves rather simply online if they wish. I did have to make an initial call to the 800 number on my plan to get distributions turned “on,” but then I was able to enter the college name, address, and amount to pay by myself online.
The check was received by the university in just days, which is the sort of service that we have come to expect from the 529 institution we use for our clients. Next semester I won’t need to call the plan at all, and I can pay the university bill at 2:37 a.m. if I get distracted by binge-watching Netflix.
Need Help? Have Questions?
If you are one of the clients that our fee-only financial planning firm serves, ask us and we will do all of this for you. We do it weekly—if not daily—for our clients. Hopefully, you know that almost anything you can ask us to do or analyze when it comes to your money is already included in the fee you pay us each year. Give us a call with your questions.
If you aren’t one of our clients, now is your chance. Give us a call and let us explain how we can help not just with college expense planning, but in all other areas of your financial life and investments.
We are happy to meet with you for free to explain how we can help, make your financial life less of a hassle, and help give you peace of mind with your money and your future. We are located in the northern part of Orange County, California, but many of our clients are scattered across the United States and the world.
Schedule a 15-minute discovery call with a fee-only financial advisor to discuss your personal situation.