Optimizing 529 Withdrawals During and After College

Congratulations to all the new graduates of 2023!  After years of saving and investing in a 529 plan, it is finally time to start using those funds to pay for college. Planning future withdrawals will help you reduce taxes, avoid penalties, and account for financial aid and scholarships. For college graduates, you may need to consider what to do with excess 529 plan funds.

In the spirit of graduation season, this will be the first of a two-part mini-series focused on 529 plans.  Today, we want to highlight best practices for using 529 funds to pay for qualified education expenses and what to do with potential excess funds after college.

 

Guidelines for 529 Withdrawals in College

• What are qualified expenses?
  • Qualified education expenses include, but are not limited to tuition and fees, room and board, books and supplies, and computer/technology costs related to coursework.
  • If a student is living off-campus, room and board costs are qualified if they do not exceed what school housing would cost.
  • Some common expenses that do not qualify include cell phones, transportation, health insurance, and sports expenses.
• Keep meticulous records:
  • While a 529 plan administrator will provide statements showing contributions and withdrawals, it’s up to the account owner to report accurately to the IRS.
  • 529 account owners should track and maintain receipts for their qualified education expenses each calendar year.
• Avoid conflicts with other tax incentives:
  • If you are claiming one of the common tax credits such as the American Opportunity Tax Credit or the Lifetime Learning Credit, you cannot pay for the same expense with a 529 withdrawal.
• Properly withdraw the funds:
  • Withdrawals from a 529 plan must match the payment of qualified education expenses in the same tax year.
  • You may choose to pay the school directly from a 529 plan, but keep in mind that it will take time for investments to be sold and funds to be mailed to the school.
  • Alternatively, you may transfer funds from the 529 plan to your bank or brokerage account. This option allows you to pay bills and then reimburse yourself in the same calendar year.

 

Guidelines for 529 Withdrawals after Graduation

What happens if you have money left over in a 529 plan after college?  Over the years, 529 savings plans have become more flexible, giving parents and grandparents several options if they do not exhaust the account:

• Pay expenses for post-graduate degrees: Unlike other education savings accounts, 529 plans do not have a specific age limit for the beneficiary. The funds can be used for graduate school and other education beyond a 4-year degree.
• Change beneficiaries: The owner of the 529 plan can change the beneficiary without tax consequences if the new beneficiary is an eligible family member of the current beneficiary.
• Pay down student loans: 529 plan owners can withdraw up to $10,000 (lifetime limit per beneficiary) to pay down qualified student loans penalty-free.
  • Note that if you use your 529 plan to make student loan payments, any interest paid is ineligible for the student loan interest deduction.
• Withdraw funds not needed due to a beneficiary’s receipt of a scholarship: 529 plan owners can withdraw up to the amount of the scholarship with no penalties.  However, the account owner will still be required to pay ordinary income taxes on the earnings.
• Roll over unused funds to a Roth IRA for the beneficiary: Beginning in 2024, the SECURE ACT 2.0 provides that a 529 beneficiary can rollover 529 plan funds into their own Roth IRA with no tax implications. The following rules apply:
  • The 529 account must have been in place for at least 15 years.
  • The beneficiary must be the same on the 529 plan and the Roth IRA.
  • There is a $35,000 lifetime limit per beneficiary, and the amount rolled into a Roth IRA each year must be within annual IRA contribution limits ($6,500 annual limit in 2023).
  • Any 529 contributions and earnings from the preceding 5 years are not eligible.
• Take a non-qualified withdrawal:  If a 529 plan owner withdraws funds for any non-qualified purpose, they must pay ordinary income taxes on the account earnings, as well as a 10% penalty on the earnings.  This option is typically a last resort, and the penalty may be waived for extenuating circumstances, such as death or disability of the beneficiary.
  • Non-qualified 529 plan withdrawals may also be subject to a recapture of state tax deductions you received when making contributions.

 

If you have questions about 529 plan withdrawals, the Glassy Mountain Advisors team is here to help.  Please contact Matt Altman (maltman@glassymountainadvisors.com) if you would like to discuss your education plan or other financial planning topics.

Additionally, stay tuned for the second part of our 529 mini-series, which will focus on starting a 529 plan and beginning the journey of saving for college.

 

 

 

 

A 529 plan is a college savings plan that allows individuals to save for college on a tax-advantaged basis. Every state offers at least one 529 plan. Before buying a 529 plan, you should inquire about the particular plan and its fees and expenses. You should also consider that certain states offer tax benefits and fee savings to in-state residents. Whether a state tax deduction and/or application fee savings are available depends on your state of residence. For tax advice, consult your tax professional. Non-qualifying distribution earnings prior to 2024 are taxable and subject to a 10% tax penalty. Beginning in 2024, unused 529 plan funds may be rolled into a Roth IRA assuming the following conditions are met: 1) must have owned the 529 plan for 15 years, 2) can only convert funds that have been in the 529 plan for at least 5 years, 3) rollover amount cannot exceed $35,000 and 4) rollovers must be made to a beneficiaries Roth IRA.

 

Glassy Mountain Advisors Inc. does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance.