529 plan rules

Know the rules when using a 529 Plan

Whether you are trying to save for elementary, secondary, or post-secondary education, a 529 Plan is still the best game in town. You can employ several tips and tricks to get the most out of 529 Plans. But before you jump right in, it’s essential to understand the various 529 plan rules completely. 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. It might seem overwhelming if you think about the total cost of education. Instead, focus on every dollar saved. Every dollar you save will be one less dollar you or your student will borrow. The interest saved on each dollar paid back over a 5, 10, or even 15-year student loan adds up.

529 Plan Education options

At one time, a 529 Plan could only be used for college or vocational expenses, but over the past few years, the options have been expanded to include

  • K-12 costs up to $10,000 per student. That applies to public, private, or religious schools.
  • Student Loans: You can now withdraw $10,000 from a 529 plan to pay the principal and interest of a qualified education loan for the plan’s beneficiary or his/her sibling. The $ 10,000 lifetime limit is per beneficiary and is not adjusted for inflation.
  • Apprenticeship programs registered and certified with the Department of Labor now qualify as higher education expenses. 529 plan funds can be used for fees, books, supplies, and required equipment. 
  • Funding a Roth IRA (more on that below)

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

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

Computers and peripherals

As crazy as it sounds, computers, up until very recently, were not considered required. Computers and tablets are now qualified expenses, as are printers, software, and internet access.

There are rules to keep in mind. No, the 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. If your student is on the 8-year graduation track, the 529 covers you. I hope that makes you feel better.

If students live off-campus or at home, room and board are covered up to a specific 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.

Student Loan Payments

The Setting Every Community Up for Retirement Enhancement Act of 2019, or SECURE Act 1.0, changed the rules to include payments to qualified education loans of the beneficiary and the beneficiary’s siblings. as qualified distributions from a 529 plan.

Remember, the IRS reduces eligibility for the Student Loan Interest Deduction when a borrower’s student loans are repaid using a distribution from a 529 college savings plan. So, no double dipping. There are several rules to understand about this provision.

  1. Qualified distributions of $10,000 per borrower, not per plan. This is a lifetime limit applying to distributions from all 529s. So, if you own a 529 and grandma owns a 529, you can’t bypass the limit by taking distributions from both 529s. 
  2. The owner can change the beneficiary to themselves or a spouse and use the 529 to pay off up to $10,000 of loans in their own name. The account owner can change the beneficiary whenever they want.
  3. Qualified student loans include all federal loans and most private student loans. 
  4. The student must have been enrolled in a degree or certificate program on at least a half-time basis during the academic term for which the loan was borrowed.
  5. The student must have been enrolled in a college or university eligible for Title IV federal student aid.

 A few states have not adopted the federal definition of qualified tuition expenses. Therefore, the state may consider using a 529 to repay student loans, a non-qualified distribution. The earnings may be subject to state income tax, and there may also be a recapture of any state income tax breaks attributable to the non-qualified distribution.

What is not covered in a 529 Plan distribution?

Non-academic fees such as athletics, student activity, clubs, parking, and transportation are not covered. Even if your student commutes, they cannot deduct mileage, gas, repairs, or other transportation costs. 

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 must include the distribution’s earnings portion as earned income. Second, you must 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 $18,000 per individual or $36,000 per couple on your PA state income tax. On the flip side, however, all non-qualified distributions must be reported as income.

Another perk for PA residents is that even if you contribute to a 529 sponsored by another state, you can still deduct your PA income tax.

529 plans are long-term investments for post-secondary education. Allowing 529s 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. 

No time limit states how long a 529 plan contribution must be in the account. However, some 529 providers have specific time limits. You can deposit the funds in a 529 on August 1 and pay the tuition bill on August 2. You will still receive a deduction or credit on your state tax return.

529 to Roth Rollover

SECURE Act 2.0, passed in December of 2022, will allow individuals to transfer funds from a 529 college savings plan to a Roth IRA. This will provide flexibility if a 529 is overfunded or a beneficiary chooses not to attend college or trade school—all tax-free.

The provision will allow individuals to transfer funds from a 529 college savings plan to a Roth IRA. It’s important to note that this provision has limitations. 

  • The 529 plan must have been open for 15 years or longer.
  • Any funds contributed over the last 5 years are ineligible.
  • No more than the annual IRA contribution limit, $6,500 (2023) or $7,500 (50+), can be moved in any given year. The beneficiary must be eligible to make Roth IRA contributions, meaning they must have earned income.
  • The typical Roth IRA income limits DO NOT APPLY!!!!!!!!!!!!
  • The maximum amount an individual can move is $35,000 per beneficiary. The funds can only be moved to a Roth IRA of the named account beneficiary. Yes, you can change the beneficiary to yourself or anyone else as often as you wish
  • There has been no common from Pennsylvania regarding their position on this.

This is a mindblowing change to the 529 options. Many of the details have yet to be worked out, and we will revisit this in a dedicated future blog post.

An unexpected change

If there’s a 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 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 decide what to do or who to make the new beneficiary.

This is just the tip of the iceberg regarding the 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 7 Frequently Asked 529 Plan Questions.