How to withdraw money from your 529 plan

Every year, maybe every month, you diligently added to your child’s college savings in a 529 plan. Maybe Grandma and Grandpa kicked in some money to help out. It never seemed like enough — but then again, college seemed so far away.

Hard to believe, but that time has come: time to send the little one (who is no longer so little) to college. And it’s time to tap into that 529 account.

But how do you withdraw funds from the account without running afoul of the qualified distribution rules? Getting it right is important, because if you get it wrong, you could end up owing taxes on any investment gains in the account, plus a 10% tax penalty.

First, know which expenses are qualified

Withdrawals from 529 plans are tax-free if the money is used to pay “qualified higher education expenses.” The IRS defines these expenses as tuition and other fees required by the institution; required books, supplies and equipment; and room and board. Computers and other technology (iPads, smartphones, etc.) do not count as qualified expenses, unless the university specifically requires the technology.

Room and board is tricky. First of all, a student must be enrolled at least “half-time” for room and board to qualify. (The definitions of full- and half-time students vary by school.) If he or she is living in the dorms or other housing owned and operated by the school, the full amount is a qualified expense. If your child is living off-campus, the qualified amount is the allowance for room and board provided by the institution’s financial aid department. This can usually be found on the university’s website.

Getting the money out of the account

You essentially have three ways to get money out of the 529 plan:

1. Have the money paid directly to the school.
2. Have the money paid to the account owner (often Mom or Dad).
3. Have the money paid to the student (the account beneficiary).

Payment directly to the school is the simplest in terms of any possible tax reporting. Keep in mind that if the student is receiving any need-based financial aid, the 529 payments might reduce future financial aid. Also be aware that this method won’t work for room and board expenses if the student isn’t living in university-owned housing and on the school’s meal plan.

Most people elect to have 529 distributions go to the account owner, who then pays the bills. If you choose this method, make sure that the distributions you take and the qualified expense payments using those distributions occur in the same calendar year. This means that if Junior brings home a tuition bill at winter break and you pay it before the end of the year, you’d better take the corresponding 529 distribution before the end of the year as well.

Having the distributions go directly to the student is actually preferable in most situations. With this method, the 1099-Q tax form will be issued in the student’s name and Social Security number. In the event any part of the distribution is deemed non-qualified, the gains will be at taxed at the student’s rate, which is probably lower than yours. Here, too, it’s important to take distributions and pay bills in the same calendar year.

As a bonus, when your child actually receives the money from the 529 plan — and writes the checks for tuition, room and board — he or she just might develop a deeper appreciation for the opportunity you’ve provided.