Paying for College: New Strategies for 529 Plans

The college experience is looking different for many kids these days and so are the strategies used in paying for college.  Parents and their kids are using 529 college savings plans, in particular, in new ways.  It’s important to know the rules on how a 529 plan can and cannot be used.

Typical Use of 529 Accounts

According to the IRS, a “qualified tuition program (QTP), also referred to as a section 529 plan, is a program established and maintained by a state, or an agency or instrumentality of a state, that allows a contributor either to prepay a beneficiary’s qualified higher education expenses at an eligible educational institution or to contribute to an account for paying those expenses.”1  Qualified higher education expenses typically include tuition, fees, room and board, books and related expenses.  For this article, we’ll focus on the more popular 529 accounts versus the prepaid tuition plans.

Why Open a 529 Savings Plan for Education Expenses?

Two basic reasons:  to create a separate, earmarked account that you will be less likely to spend on something else and to save a little on income taxes.  Contributions you make cannot be deducted from income for federal taxes, but 34 states (North Carolina is not one of those) offer some state tax deduction on contributions.  Growth in the accounts is tax deferred (no taxes due on interest, dividends or capital gains inside the account) and, when used to pay qualified educational expenses, the earnings can be withdrawn tax-free in addition to the contributions.

Using 529 Plans in a Pandemic

Let’s say you’ve done a great job of saving plenty in a 529 plan for your child and then a pandemic hits.  You might decide to have your kid live off campus with just one close friend and avoid the dorm life petri dish.  Can you withdraw funds from the 529 to pay the rent?  Yes, with limitations.  Withdrawals to cover the cost of off-campus housing cannot exceed the room and board portion of the college’s published estimated cost of attendance, and the student must be enrolled at least ½ time.  For example, Appalachian State University lists the estimated cost for room & board as $9,174 per year for on-campus and $9,615 for off-campus living.  Keep good records, including receipts for the “board” portion of grocery bills.  The IRS may want to see those later.  Tell the kiddo not to include six packs of hard seltzer on her grocery store receipt, but, it’s OK to give you receipts for internet service or a lap top that’s used for class work.

What if the college goes to all online classes and your kids comes home to live in the basement?  After the grieving period for all concerned, will you think about charging rent to the basement dweller and pay for it out of his 529 account?  Technically, you can, but tread carefully.  App State lists an estimate for room & board for a student living with parents or relatives as $3,792, a good bit less than on- or off-campus living.  You could draft a lease to make it legit, but then you’d also be looking at including the rental income as taxable income for the parents.  That’s probably not worth the hassle just to be able to use all the 529 money in a tax-efficient way.

Other Uses for the 529 Plan Funds

What if your child decides college is for chumps and you have a bunch saved for their education?  They can now use 529 plan funds to pay for apprenticeship programs that are registered with the Department of Labor.  This new provision was created under the SECURE Act passed in 2019.

That legislation also allowed use of up to $10,000 from a 529 plan to pay off student loans.  You could change the beneficiary on the 529 account from the child choosing not to attend college to an older sibling and pay off some of their debt.

Another option available is to use those funds to pay for primary education for their younger sibling.  It is now allowable to use 529 plan funds to pay for up to $10,000 per year in private school tuition before college.

Lastly, if there are no other kids in the family that could use the 529 money for education, you could change the beneficiary to mom or dad and help them go back to school.

~Dave Werle


Sources: 1. The Internal Revenue Service

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Any opinions are those of David Werle and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notices.

Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Prior to making an investment decision, please consult with your financial advisor about your individual situation. You should discuss any tax or legal matters with the appropriate professional.

Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 college savings plan.  Such benefits include financial aid, scholarship funds, and protection from creditors.

As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. The tax implications can vary significantly from state to state. Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan.