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A 529 Education Savings Plan is an investment account that allows families to save tax-free for a child’s education-related expenses. States administer these plans, and while you don’t have to use the one offered by your home state, you can get additional tax breaks for doing so.
If your child receives generous scholarships or chooses not to attend college, you may find, when they reach college age, that you have actually diligently saved too much in a plan. 529. But because these plans come with relatively strict rules about how the money can be used, the consequences of simply withdrawing the money for yourself can be severe.
Spending 529 on ineligible expenses means you’ll pay a 10% penalty and income tax on the part of the withdrawal that includes investment income. But there are many ways to withdraw money for tuition and not face a withdrawal penalty. Here are your options.
1. Understand what counts as an eligible expense
First, make sure that you are clear about the specific expenses that you can pay with the 529 savings plan. These include tuition, fees, accommodation, meals, a computer, materials and books, as long as they are needed for the student’s classes.
If the student lives off campus, 529 funds can only be used up to the school’s official allowance for accommodation and meals, calculated in their tuition cost for financial aid purposes. You can find this number on the school’s financial aid website.
If you use the money for unauthorized expenses, only the withdrawal amount that has increased (or earned) as a result of your deposit is subject to tax and penalties. You will not be penalized for withdrawing your own initial contributions to the plan.
2. Use the scholarship withdrawal rules
If you have 529 additional funds in the plan because your child received a college scholarship, there is an exception to the penalty rules that is tailor-made for you. You don’t have to pay the 10% investment income penalty when you withdraw money up to your child’s scholarship amount. However, you will have to pay income tax.
This means that it is still worth it for families to save in a 529 plan, despite the risk that their child could eventually receive a scholarship. The plan offers a way to make your money grow, even if it is ultimately taxed upon withdrawal, like money in a taxable brokerage account.
3. Use the money for higher education
There is no time period when you have to use the money you saved in a 529 plan. It can stay in the account for as long as you want, but it may have to be used for education costs. of the beneficiary to avoid taxes and penalties.
If there is a good chance that your child will be able to attend higher education – they are determined to study medicine, for example, or if they are pursuing an area that will require a master’s degree – you can keep the 529 funds in the plan and plan ahead. your child will take them out in the future.
4. Change the beneficiary into a family member
You can also transfer the funds to another family member. While 529 plans have very detailed withdrawal rules, they also offer generous options for letting another family member take over the plan. This person can then use the balance for their own education expenses.
If your child was the original beneficiary of the plan, for example, you can change the beneficiary to an eligible family member. This includes any of their siblings, parents, first cousins, nieces, nephews, or even their own spouse or child. So, in practice, as a parent interested in pursuing higher education, you could become the beneficiary of the plan and use the funds for your own education. Or you can leave them there for a future grandchild.
5. Pay Kindergarten to Grade 12 Tuition
529 plans should not be used just for college expenses. The IRS allows up to $ 10,000 in the 529 plan funds to cover tuition and public, private or religious school fees from Kindergarten to Grade 12 for the beneficiary. But make sure your state allows this type of withdrawal from its plan.
If allowed, it means that you can transfer the 529 plan to another child who attends a private school, for example, such as the brother or cousin of the original beneficiary. Or, you can leave the funds in the plan for a future grandchild so they can use the money for K-12 tuition or college fees.
6. Repay student loans
Another withdrawal option is to use 529 plan funds to pay off student loans. Up to $ 10,000 in 529 plan funds can be used to repay student loans from the plan beneficiary, and an additional $ 10,000 can be used to repay loans held by a beneficiary’s sibling.
This means that any money left in the original beneficiary’s plan can be used to pay off a sibling’s student loans. Or a parent could change the beneficiary for themselves and use the extra 529 funds in the plan to pay off loans they took on to cover another child’s education – or their own – education.
At the end of the line
The complexity of 529 plans can make withdrawing your money as difficult as meeting your savings goals. But because of the many exceptions to these rules, there are plenty of creative ways to put your money to good use.