Dec 04, 2018
By Todd Helle, EA Partner and Tax Director at Terry Lockridge & Dunn
Withdrawals from 529 plans are not taxed at the federal level, as long as you understand and follow the rules.
To the extent you withdraw an amount less than or equal to your payments for qualifying higher education expenses (QHEE) in the same calendar year, there is no income taxed on the 529 distribution.
Qualified Higher Education Expenses include the following items:
- Tuition and Fees for all accredited post-secondary educational institutions
- Books and Supplies required by the post-secondary educational institutions
- Computer used for college
- Room and board for college if the student is enrolled at least half-time
- If student lives off campus, then room and board costs cannot exceed the greater of the following 2 amounts:
- The allowance for room and board included in the school’s cost of attendance for federal financial aid calculations
- The actual amount charged if the student is living on campus
Items that do not qualify as QHEE:
- Room and board if less than half-time student at college
- Transportation costs
- Health insurance even if offered by the college
- Student loan payments
- Books that are not required reading for college course
Qualified withdrawals are federal income tax free, as long as the withdrawals do not exceed your child’s adjusted QHEE. To calculate the adjusted QHEE, add up all of the qualified expenses and subtract from that amount any tax-free educational assistance. Examples of these are Pell Grants, tax-free scholarships, tax-free employer education assistance, and Veteran Educational Assistance. If your income level makes you eligible for American Opportunity Credit (AOC), you would want to reduce your withdrawal by the additional $4,000 costs used for this credit.
It is important to match up the timing of the 529 withdrawal with the payments of qualified educational expenses in the same calendar year. If you make a payment personally for QHEEs at the end of 2018, you must make sure to take the 529 withdrawal by the end of 2018. If the 529 withdrawal happens in January of 2019, then you cannot count the QHEE’s paid in 2018.
A better option would be to pay the college directly from the 529 plan. It takes time to process transactions with 529 plans; it can take from seven to ten days. If you have multiple 529 plans for your children and you want to use funds from multiple accounts to pay for one child, you need to first transfer funds from sibling’s 529 account to the child’s 529 account, who is incurring the QHEEs, then take the withdrawal.
This can be a complicated matter. If you have additional questions, please contact Todd at firstname.lastname@example.org, or any of the accountants at Terry Lockridge & Dunn. They can be reached at 319-364-2945 in Cedar Rapids, or 319-339-4884 in Iowa City.