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According to the Education Data Initiative, the average cost of college is around $38,000 per student per year, including books, supplies, and daily living expenses. Many parents may turn to a tax-advantaged 529 plan which may help families save and pay for a college education.
Before opening a 529 plan for a dependent child, however, it is essential for the parents and guardians to understand the 529 plan and how to withdraw from a plan wisely.
What is a 529 plan?
A 529 plan is an educational savings plan that is sponsored by a state usually where the dependent lives. The plan helps parents, guardians and dependents set aside money to pay for educational expenses. The gain on the investment can be maximized if investing a plan earlier.
How 529 Plans Are Taxed
Contributions to a 529 plan are not tax deductible for federal income tax purposes. However, most states provide tax deduction or credit which can help to offset taxes.
529 Plan Best Practices
Before withdrawing funds from a 529 account to pay for a dependent’s college education, account holders may need to consider below to maximize tax benefits while avoiding the potential penalties.
Ready to learn how to save on taxes as a caregiver? Read more here
Understand Qualified Education Expenses
529 funds used for qualified education expenses are tax-free and the annual limit for the tax-free funds is $10,000. If the funds is used for purposes other than qualified education expenses, it will be subject to taxes and an additional penalty of up to 10%.
Typically, qualified education expenses include:
- Tuition and fees
- Room and board (in most cases, though there are exceptions)
- Textbooks and supplies required for classes
- Computers and related tech/equipment
Plan Carefully for Withdrawals
Withdrawals from a 529 account can be directly sent to the school to cover educational expenses or move the money from a 529 account into a personal bank account. Funds can take several days to process, so it is important to plan for plenty of time when requesting the withdrawal to meet the payment deadline.
Keep Receipts and Detailed Records
Although an annual statement will be provided to account holders with details of contributions, earnings and withdrawals, account holders are responsible for keeping records of all their withdrawals and spending. Receipts or other documentation can show proof if any issue arises.
What's Next?
The funds from a 529 plan can not only be used to pay for college expenses, but trade schools and other educational settings. Understanding how to make withdrawals wisely to maximize tax benefits and minimize potential penalties is the key to make sure that the funds from a 529 plan are used effectively.
Interested in learning how to prepare for fall taxes? Read more here
Have questions? We would love to help!
If you have any questions or would like additional information about anything mentioned, please comment below or email us at askus@lgt-cpa.com
