06 Sep Spending strategies for 529 Plans
Q. I have a 529 plan and my daughter starts college this year. It won’t be enough to cover all four years. Should I use the 529 for all her expenses like books and spending money, or should I save it all for tuition? She will need to take a loan by the time she’s a junior.
A. It’s tough to balance all the costs associated with a college education.
But with 529 plans, you have to follow the rules.
Withdrawals from a Section 529 plan are tax-free to the extent your daughter has “qualified higher education expenses,” said Roy Williams, president and founder of Prestige Wealth Management in Flemington and Millburn.
He said qualified expenses include tuition, books, fees, supplies, computer and related expenses. Room and board is also a qualified expense but is subject to limitations.
Spending money on its own is a non-qualified expense, Williams said.
“Withdrawals from a 529 plan for a non-qualified expense are taxable and also subject to a 10 percent tax penalty on the earnings portion of the withdrawal,” he said. “Therefore, you should probably not use the funds in the plan for spending money.”
You also need to take into account certain tax incentives in determining the amount of qualified higher education expenses.
For example, he said, you must deduct any tuition payments used to generate an American Opportunity Tax Credit or Lifetime Learning Credit from the amount of qualified higher education expenses.
As to the timing of when to use the 529 money versus taking on loans, that gets a bit more complicated if you are eligible for federal aid or scholarships, he said.
“This is because you need to take into account how 529 money is considered on the FAFSA form and how the school your child will be attending takes it into account when providing scholarship money,” he said, noting that each school can have different rules.
Williams said from an investment perspective, he recommends that funds needed for education within two to three years be out of the potentially volatile stock market and invested in cash/money market or very low duration bonds.
“So by using the 529 money in the first years, you are not giving up much in investment returns but you’re deferring the beginning of the accumulation of interest on the loan itself,” he said.
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This post was first published in September 2016.NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.