What Expenses Can Be Paid With 529 Funds?
If you've got a child entering college in the near future, hopefully, you've also got a 529 account in place and ready to cover some of the costs of tuition and all the other associated expenses. Keep in mind, you can withdraw money from a 529 plan at any time for any reason.
As long as you use the funds for a qualified distribution, the money comes out tax-free. However, for a non-qualified distribution, you will incur income tax and a 10% penalty on the earnings portion. To enjoy the full tax benefits of a 529 plan, funds must be used to pay for qualified higher education expenses. When it comes to paying that college bill, you probably have some questions. What exactly are “qualified expenses”? What expenses can be paid tax-free from the 529 plan? And perhaps most importantly, what things can you NOT use your 529 funds for?
What is a Qualified Expense?
The IRS defines qualified education expenses as “expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution”. The word "designated beneficiary" refers to the person named in your 529 plan and can be a child, a grandchild, a relative, a friend, or even yourself.
An "eligible educational institution" includes almost all accredited post-secondary institutions, even some international institutions. See the list of eligible education institutions here by clicking here.
Examples of Qualified Expenses What are qualified expenses that can be paid with 529 money?
Books, supplies, and equipment
Expenses for special needs services necessary for the student to be able to attend college
Room and board (as long as the student attends more than half time)
Computer or peripheral equipment, computer software, or internet access
Text Books Are Expensive!
Don't forget about textbooks - and be sure to save your receipts. Assuming you purchase textbooks with personal funds, you can get reimbursed by your 529 plan if you show the receipts. You might have guessed that with online shopping and e-books, that the price of textbooks would have gone down. Think again. Over the past 10 years, the average cost of college textbooks has risen four times faster than the rate of inflation. Fortunately, textbooks are a qualified expense and 529 funds can almost certainly be used to pay for them. Textbooks need to be required reading for the course. Supplies and equipment also have to be required items for the course in order for 529 funds to be used.
Room & Board
More good news: payment for a dorm room on campus is included as a qualified 529 expense. Furthermore, off-campus housing may be included too. One important caveat for room & board: the student must be enrolled at least half-time. The cost for off-campus housing cannot exceed the allowance for room and board set by the college in their cost of attendance calculations.
Computers, Fees, Etc: The Devil is in the Details
Computers need to be used by the student during their time enrolled in school. And no, software used for entertainment like video games does not count as a qualified expense! Cell phones are not included as a qualified expense.
For the most part, optional fees aren't covered. You can't include parking or similar “optional” fees a student chooses to buy since parking is not considered a requirement for attendance at the college. Additionally, it doesn't include health or other insurance payments (even when purchased through the college). Sports expenses or health club memberships are also not covered.
Potential Pitfalls: Expenses NOT Covered
Health insurance, parking, and football tickets, transportation costs are among the items not considered a qualified expense. Even though the student does need to get to and from college, it is not considered a necessary expense. If the college is a good distance away, parents should factor travel costs into their financial plans for payment out of their pockets. Costs incurred prior to college, such as application and testing fees, are also not considered qualified expenses. Although these costs are required for admission, they are not required for enrollment or attendance. Finally, 529 funds cannot be used to make student loan payments.
Finally: Pace Yourself
Most people have not saved 100% of the costs of college in a 529 account. Many parents use all their 529 savings before turning to other funding sources. This is often a mistake. They use the 529 funds for every expense during their child's freshmen year and then sophomore year, and so on. In many cases, they’ve used up all of their 529 funds and are forced to use student loans to pay for the remaining semesters. What they may not understand is that federal student loan amounts (typically the best student loans to start with) are capped to a certain amount each year. For example, during junior year, a student can only borrow $7,500 in federal loans. This might leave a large gap to be filled by private loans because they’ve used up all their 529 money. There's a better strategy: pace yourself. Instead of using all of your 529 funds first, I recommend planning all four years out in advance. Take advantage of the available federal student loan amount EACH year starting with freshmen year and spread out the 529 distributions, too. There's another benefit to this strategy: 529 savings plans allow for your investment to grow tax-free. Use an efficient distribution strategy (one planned out ahead of time) to withdraw funds in the smartest way possible to make the most of the tax benefit.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Alyssa Lum, and all rights are reserved. Read the full Disclaimer.