Question

During the year, G withdrew $12,000 from a 529 plan for his daughter. He used the most of the money to pay for the following costs associated with her first year of college: tuition $10,000, fees $1,000, apartment rental $3,000, computer $1,600, books $400, appliances and furniture $505, and bedding $200. How will the $18,000 be treated?

Answer 1

529 withdrawals are tax-free to the extent your child (or other account beneficiary) incurs qualified education expenses (QHEE) during the year. If you withdraw more than the QHEE, the excess is a non-qualified distribution. You or your beneficiary—you get to choose who receives the money—will have to report taxable income and pay a 10% federal penalty tax on the earnings portion of the non-qualified distribution. The principal portion of your 529 withdrawal is not subject to tax or penalty.

QHEE includes tuition, fees, books, supplies, computers and related equipment, and the additional expenses of a "special needs" beneficiary. For students who are pursuing a degree on at least a half-time basis, QHEE also includes a limited amount of room and board. As of January 1, 2018, qualified expenses include up to $10,000 in tuition expenses at private, public or religious elementary, middle and high schools (per year, per beneficiary). You CANNOT include the following college expenses:

• Insurance, sports or club activity fees, and many other types of fees that may be charged to your students but are not required as a condition of enrollment
• Transportation costs
• Repayment of student loans
• Room and board costs in excess of the amount the school includes in its "cost of attendance" figures for federal financial aid purposes. If your student is living off campus, ask the financial aid department for the room and board allowance for students living at home with parents, or living elsewhere off campus, as the case may be. If the student is living in campus-owned dormitories, the amount you can include in QHEE is the amount the school charges for its room and board.

Even if you've properly accounted for all qualifying expenses, and withdraw from your 529 account only enough to pay for those expenses, you may end up with a non-qualified distribution. This happens because of the coordination rules (aka anti-double-dipping rules) surrounding the various education tax incentives. You must remove from your total QHEE any of the tuition expense that is used to generate an American Opportunity tax credit or a Lifetime Learning credit. For example, if you claim a $2,500 American Opportunity credit on a federal tax return you must remove from QHEE the $4,000 in tuition and related expenses that was used to support the credit.

What can you do if you receive a distribution check from your 529 plan only to discover after speaking with your accountant that you've taken too much? If you are still within the 60-day rollover window, you can take the excess and roll it into a different 529 plan so that amount is no longer treated as a distribution, provided you have not rolled over that child's 529 account within the prior 12 months. If you are outside the 60-day window, but within the same calendar year, you can look to prepay next year's expenses to increase this year's QHEE. If you discover the excess 529 withdrawal after year-end, there's not much you can do about it. The good news is that if the non-qualified distribution is caused by the tax-credit adjustment described above, the 10% penalty is waived.

oom and board costs make up a large portion of a student’s total college bill, second only to tuition. If you’ve been saving for college in a 529 plan you can withdraw funds tax-free to pay for room and board, but only if certain requirements are met.

Costs of room and board

According to the College Board, average room and board costs for the 2017-18 school year were around $10,000 for public four-year colleges (in-state or out-of-state) and $12,000 for private four-year colleges, up 3.1% and 3.6% from the previous year, respectively.

Qualified 529 plan expenses

With a 529 college savings plan, investments grow tax-free and are not taxed when withdrawn to pay for qualified higher education expenses, including tuition, fees, supplies and equipment required for enrollment, special needs services and, in some cases, room and board costs. If funds are used for non-qualified purchases, the earnings portion of the distribution will incur ordinary income tax plus a 10% penalty.

For room and board expenses to be considered qualified, the student has to be enrolled in an eligible college program on at least a half-time basis. Qualified room and board costs can include both on- and off-campus housing costs, as long as they were incurred during an academic period during which the student is enrolled or accepted for enrollment in a degree or certificate program or another program leading to a recognized education credential. Enrollment in a study abroad program counts, so long as it is approved for credit by the student’s home college or university.

Paying for room and board with a 529 plan

If the student is living on-campus, their qualified room and board costs will be equal to the actual invoice amount they are charged for housing owned or operated by the college. This typically includes housing costs and a meal plan.

But for students residing in apartments or other off-campus housing, qualified room and board costs must be less than or equal to what is included in the college’s cost of attendance (COA) allowance for room and board for the period. The COA estimates a student’s total cost of college in a given year, which includes tuition, fees, room and board, transportation, books, supplies and equipment and other expenses, and is used to determine need-based financial aid eligibility. (Keep in mind that not all items included in the college’s COA are considered qualified expenses for 529 plan purposes).

Students can obtain their school’s room and board allowance for residing off-campus from the college’s website or the financial aid department. The college will typically provide an allowance for those who reside in apartments as well as those who live at home with their parents during the school year. While living off-campus, add up the receipts from any rent, utilities, groceries or other housing expenses each year until you reach the maximum amount for a tax-free 529 plan withdrawal.

When adding up your total 529 plan qualifying expenses for the year (including tuition, fees etc.), don’t forget to subtract any costs used to generate the American Opportunity Tax Credit or Lifetime Learning Tax Credit. Double-dipping with other education tax benefits could trigger a non-qualified withdrawal. Also, be sure to take the distribution in the same year that the qualified expense was paid. 529 plans typically let you distribute funds to the account owner, the beneficiary or the school. Some 529 plans will let you make a payment directly to an off-campus landlord.