529 plan rules

Know the rules when using a 529 Plan

*529 plan rules updated 1/2/2018 – The Tax Cuts and Jobs Act of 2017 now allow 529 plan funds to be used, tax-free, of course, for K-12 costs, up to $10,000 per student. That applies to public, private, or religious schools. Previously, 529s could only be used to cover costs for college.

Also, homeschooling expenses will be covered by 529 plan distributions. The $10,00 per student limit also applies. All educational materials, tutors, and therapies are covered.

Whether you are trying to save for elementary, secondary, or post-secondary education, a 529 Plan is still the best game in town. But before you jump right in it’s essential to have a complete understanding of the various 529 plan rules.  Using a 529 Plan requires planning and attention to detail.

A drop in the Ocean

I’m not going out on a limb when I say most people will not be able to save the entire amount of tuition in a 529 plan. If you think about the total cost of education, it might seem overwhelming.

Instead, focus on every dollar saved. Every dollar you save will be one less dollar that you will borrow. The interest saved on each dollar paid back over a 5, 10, or even 15-year student loan adds up.

If it’s not required, it’s not qualified

The first rule is that the expense must be necessary for enrolment/attendance. Tuitions, books, supplies, and equipment are the most obvious. Be careful, though, the supplies and equipment must be required.

Computers and peripherals

As crazy as it sounds computers, up until very recently, were not considered required. The remarkable part is not only are computers and tablets now qualified expenses but so are printers, software, and internet access.

There are rules to keep in mind. Software does not include gaming. It must be for education. Also, if internet access is bundled with cable TV, you can’t use 529 funds to pay for HBO.

Dorms, off-campus, or parents’ basement

If you’re enrolled on at least a half-time basis, you can deduct room and board, which includes your meal plan. Yes, if your student is on the 8-year graduation track, the 529 has got you covered. I hope that makes you feel better.

If students live off campus or even at home, room and board are covered up to a certain limit.  For example, If your college charges $8,000 for a dorm room and meals, but you live off campus and make your meals, you can claim up to $8,000. You cannot claim more than what your school allows for room and board. This info is readily available through the school’s financial aid department.

What about commuter students? If you have a commuter student, you can still use a 529 plan to cover the equivalent cost of attendance for room and meals. It’s much lower, but each school has the equivalent “living at home cost” info. This figure is the allowable qualified expense you can claim. *living at home cost does not apply to K-12.

What is not covered in a 529 Plan distribution?

Non-academic fees such as athletic, student activity, club, parking, and transportation fees are not covered. Even if your student commutes, they cannot deduct mileage, gas, repairs, or any other transportation cost. If you have a student loan and want to pay it with a distribution from a 529, sorry, can’t do that either.

Saving Taxes

Saving taxes is always an attention getter. Besides saving for college, everyone wants to save on taxes. Yes, as long as distributions are used for qualified education expenses, you will not pay any taxes on earnings.

What happens if there are non-qualified distributions? First, you have to include the earnings portion of the distribution as earned income. Second, you have to pay an additional 10% penalty on the earnings.

If you’re lucky enough to live in one of the states that allow a state deduction for 529 contributions, that’s even better. Pennsylvania has one of the most generous tax deductions for residents. You can deduct up to $14,000 per individual or $28,000 per couple on your PA state income tax, but all non-qualified distributions must be reported as income.

Another perk for PA residents, even if you contribute to a 529 sponsored by another state you are allowed to take a deduction on your PA income tax.

529 plans are long-term investments for post-secondary education. Allowing 529’s to be used for k-12 costs does go against that. But, and this is a big but, 35 states offer a tax deduction or credit for 529 contributions. If you have children in private school (or home school), it will benefit you to fund their tuition, books, etc., into a 529 plan. There is no time limit stating how long a 529 plan contribution needs to be in the account. You can deposit the funds in a 529 on August 1st and pay the tuition bill on August 2. You still will receive a deduction or credit on your state tax return.

An unexpected change

If there’s refund for any reason from the school, a redeposit in the 529 is allowed. The funds must be redeposited within 60 days of the refund to avoid penalties. It could be temporary, such as a sickness, or maybe college isn’t for that particular student. It doesn’t matter.

Continuing education isn’t for everyone

A big fear that people have is what happens if their student does not go to college or vocational school? There aren’t that many options. You can change the beneficiary to another family member, or take a distribution and pay income tax and a 10% penalty on the earnings.

There’s no time limit for withdrawals so you can take your time deciding what to do or who to make the new beneficiary.

This is just the tip of the iceberg when it comes to 529 Plan rules. Consider this the intro course to give you an overview of the benefits and traps.

 If you want to learn even more about 529 Plans, check out our post 6 Frequently Asked 529 Plan Questions

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