Paying for College with a 529 Plan

Last week a college student emailed a question about using money from his 529 Plan to pay for college costs, including room and board.  His question prompted this blog entry.

First some background: Qualified Tuition Programs, commonly known as “529 Plans” after the section of IRS code that created them, offer a great way to save for college with tax benefits.  When it comes time to take money out of your account to cover college costs, though, it’s critical to follow IRS regulations in order to avoid penalties.

If you are a student or have dependents who are students in college or nearing college, you may be aware that money you spend on tuition and required books makes you eligible for a really valuable federal income tax credit.  Most college students are eligible for the American Opportunity Credit, which can be up to $2,500 per student; in some cases eligibility rules mean that the Lifetime Learning Credit, which is smaller but still a nice credit, must be used.  The more you spend on tuition and books, the higher your tax credit will be, up to a limit of $4,000 in expenses.  The key, though, is that you can’t count any tuition or book expense that was paid for with money from scholarships or grants, or from tax-advantaged accounts.

Therefore, it’s not generally a first choice to use money from your 529 plan to pay for your entire tuition bill and books.  If you do, you won’t be able to claim that great tax credit.  Instead, try to use money from your regular savings or use student loan money to pay for your tuition (after any scholarships and grants that may cover part of the tuition).

“But I have this money saved for college in my 529 plan! Are you telling me I shouldn’t use it?”  No, that’s not what I’m saying.  The good news is that funds from your 529 plan can be used for room and board! So your first choice should be to use 529 plan funds for your room and board expenses, while using money from ordinary accounts to pay for tuition.

How much can I withdraw from my 529 plan for room and board?  As mentioned earlier, you want to stay within the rules for Qualified Distributions; those rules are spelled out in chapter 8 of IRS Publication 970.  There’s no set maximum dollar amount, since costs vary at colleges across the nation. Instead, the rules refer you to the room and board allowance set by your school for financial aid purposes.  You can make qualified withdrawals for room and board up to that amount, BUT it can’t be more than what you actually spent.  Therefore some suggestions:

  1. Look up your school’s room and board allowance and divide it per semester so you have a maximum figure for the current tax year.
  2. Keep track of your expenses so you can prove how much money your spend on room and board.

In addition to tuition, books, and room and board, you can also make qualified 529 plan withdrawals for special needs services, and for a computer and related equipment that is to be used primarily by the student for educational purposes.  See Publication 970 for details.

To learn more about Iowa’s 529 plan, go to www.collegesavingsiowa.com 

 

Barb Wollan

Barb Wollan's goal as a Family Finance program specialist with Iowa State University Extension and Outreach is to help people use their money according to THEIR priorities. She provides information and tools, and then encourages folks to focus on what they control: their own decisions about what to do with the money they have.

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College saving: more than money

I can personally testify to the financial benefit of saving for my children’s education: I started monthly automatic transfers into their college savings accounts when they were young, and at the same time helped them establish a habit of saving a portion of their allowance each month.  My daughters reaped the financial benefits of that saving during college, and continue to benefit as young adults without school loans to repay.

I didn’t know it, but my children benefited in other ways — yours can, too.  Here’s why: children who have savings that is specifically set aside for their education and career goals actually make greater academic progress than children who do not, all other things being equal.  They do better in school, are more likely to finish high school, and are more likely to attend and complete an educational program after high school.

Even though I didn’t know about this research back then, it makes sense to me.  Having a savings account means we’re thinking about the future. It creates a vision for steps beyond high school.  It builds hope and a belief that they can do it, and is a motivator. Having a vision for the future is extremely powerful.

Having savings doesn’t guarantee school success, of course, but it makes it more likely. The benefit of savings is especially strong for children in lower-income families. Research also shows that even small savings makes a difference – even amounts less than $500 have an impact.  Only a small part of the benefit comes from the actual monetary value in the account; most of the benefit results from expanding young people’s vision for their future.

Think of the children in your life. Over the summer, families may be purposeful about encouraging library visits or enrolling children in learning-oriented camps.  Those are great ideas. But it turns out those aren’t the only ways to boost academics!  Build your child’s vision for the future by starting or adding to an education savings account in his or her name. Get them involved too!

Barb Wollan

Barb Wollan's goal as a Family Finance program specialist with Iowa State University Extension and Outreach is to help people use their money according to THEIR priorities. She provides information and tools, and then encourages folks to focus on what they control: their own decisions about what to do with the money they have.

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