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Qualified Education Expenses and 529 Accounts — Miguel Gomez

Miguel Gomez, Lauterbach Financial Advisors, El Paso, Texas

There are several reasons people use 529 plans to save for their children’s education. For example, the account owner (typically the child’s parents, but it can also be other family members) keeps control of the funds. Another reason is that they are low-maintenance (each plan has a purposely limited number of investment options).

The challenge can be when parents begin taking money out of the plan. If you pay qualified expenses, there is no tax on the earnings withdrawn from the account, but if you purchase something that does not qualify, then the earnings portion of the withdrawal will be taxed at your income tax rates and, additionally, will incur a 10 percent penalty.

The following list (from IRS Publication 970) is intended to define what the IRS considers qualified expenses. It applies to half-time and full-time students attending qualified educational institutions, which are defined as any college, university, vocational school or other postsecondary educational institution eligible to participate in a student-aid program managed by the U.S. Department of Education:

  1. Tuition
  2. Books, supplies and equipment (only those required by the institution)
  3. Room and board expenses, (limited to the amounts published by the college the child attends). For example, if your child lives on campus, the entire room expense would qualify.

Important Points to Remember

  • Although an overwhelming majority of accredited, public and private postsecondary institutions are deemed as qualified, it is a good idea to verify if that is the case with the school your child is considering.
  • Distributions (withdrawals) from 529 accounts can be made payable by check to anyone you choose. If you limit your withdrawals to a qualifying college or university, the full amount (up to the school limits) would be deemed as qualified. Withdrawals made to other people/companies (including yourself as plan owner or your child as beneficiary) are reported through a 1099-Q. This 1099 form will show the total withdrawals from the account for the year along with the corresponding earnings portion and tax basis.
  • It is extremely important to keep accurate records of all the qualified expenses made because the earnings portion for any expense that does not qualify (or an expense that can’t be justified with a receipt/record) will be taxable at income tax rates and will incur an additional 10 percent penalty. The 1099-Q will show the earnings portion for all the withdrawals taken. You (or your accountant) need to determine what portions of those expenses were considered qualified and which were not.
  • Personal expenses are not considered qualified. Examples of personal expenses are furniture, electronic equipment not required by the institution, entertainment, transportation to and from school, and discretionary (non-required) school activities, such as fraternities, sports or clubs.
  • If your child decides not to attend college and does not need to use the funds in his or her 529 account, or if there are funds left in the account once your child finishes school, you can use them to pay for additional education for yourself, your spouse or other family members.

Keeping It Simple

For parents ready to begin withdrawing from a 529 account, here are a few suggestions to keep it simple:

  • You should focus first on paying for big-ticket items (such as tuition and room and board) through the plan.
  • If you decide to use the funds for anything other than tuition and room and board, you should document all qualified expenses paid from the 529 account by keeping all sales receipts to verify how the withdrawals were used.
  • Determine how much you will need for each semester before making any withdrawals. The excitement of having a child head off to college may lead you to withdraw from the plan without first setting a budget. This, in turn, could mean you take out more than is actually needed, and as a result, you could have to pay taxes and penalties that would have been easily avoided had you started with a budget as a guide.

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2013, The BAM ALLIANCE

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Lauterbach Financial Advisors, El Paso, TX

Miguel Gomez is a client experience and marketing associate for Lauterbach Financial Advisors, LLC, an independent member of the BAM ALLIANCE.

Miguel’s primary focus is on creating initiatives to strengthen client relationships and relaying the Lauterbach story to the public and the media.

He’s been a speaker in various community events and has been a guest in radio, television and print publications discussing topics such as investing, marketing and immigration. Miguel also writes a personal finance column for Ser Empresario, a monthly business magazine distributed in the El Paso-Juarez region.

Miguel holds a marketing degree from the Monterrey Institute of Technology in Queretaro, Mexico. He is currently preparing to obtain the CFP® certification.

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