Withdrawing from a 529 Account: A Guide for Parents and Grandparents

When the time comes to pay for college, it's important to understand what is involved in withdrawing funds from a 529 plan, including reimbursing yourself, paying the school directly, and important considerations like FAFSA implications and qualifying expenses. 

Parent-Owned 529 Plans:

Determine the qualified expenses: Before making a withdrawal, it's crucial to understand what expenses are considered qualified and eligible for 529 funds. Qualified expenses typically include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. 

Keep track of receipts: To ensure smooth withdrawals and proper documentation, it's important to maintain receipts and records of all qualified expenses paid from the 529 plan.

Reimburse yourself: If you have paid for qualified expenses out of pocket, you can withdraw funds from your parent-owned 529 plan to reimburse yourself. It is crucial to ensure that the withdrawal amount matches the expenses incurred and that the withdrawal is taken in the same year as the expense. 

Pay the school directly: Another option is to request a direct payment from the 529 plan to the educational institution. This can simplify the process and eliminate the need for reimbursement. Coordinate with the school's financial aid office to facilitate the payment.

Impact on financial aid eligibility: Withdrawals from parent-owned 529 plans do not count as income on the FAFSA, potentially preserving the student's eligibility for need-based financial aid.

Grandparent-Owned 529 Plans:

Be mindful of FAFSA implications: Funds withdrawn from a grandparent-owned 529 plan are considered untaxed income to the beneficiary (student) on the following year's FAFSA. This can impact the student's eligibility for need-based financial aid. Consider timing the withdrawal strategically to minimize its effect on financial aid.

Coordinate with the account owner: Since the grandparent owns the 529 plan, they should initiate the withdrawal. However, some plans may allow the account owner to designate the student's parent as an authorized person who can request withdrawals.

Make payments to the school: If funds from a grandparent-owned 529 plan are intended to pay for qualified educational expenses, it is best to have the funds sent directly to the educational institution to avoid potential FAFSA complications.

Timing of withdrawals: Since FAFSA uses income data from the prior-prior year, it's advantageous to postpone withdrawals from grandparent-owned 529 plans until the student's junior or senior year of college. This way, it will not affect the initial FAFSA filing but may impact aid eligibility for subsequent years.

Other Considerations 

In some cases, you may find yourself in a situation where you need to withdraw funds from a 529 plan for nonqualified expenses. Withdrawing funds for nonqualified expenses will incur income tax and a 10% penalty on the earnings portion of the withdrawal. However, the original contributions to the plan are not subject to these penalties. 

If your child receives a scholarship, you have a few options regarding the 529 plan. You can withdraw an amount equal to the scholarship without incurring the 10% penalty, though you will need to pay income tax on the earnings portion. Alternatively, you can leave the funds in the 529 plan, as they can still be used for other qualified expenses such as books, supplies, or even graduate school in the future. A 529 plan can also be used to pay for private K-12 school tuition, up to a maximum of $10,000 per year per student.

In the event that your child decides not to attend college or pursue higher education, you still have options for the 529 plan funds. Firstly, you can change the beneficiary to another eligible family member who may be planning to attend college in the future. This way, you can still utilize the funds for their education expenses. Additionally, you can keep the funds in the 529 plan in case your child decides to return to school at a later time. However, if these options are not viable, you can withdraw the funds for nonqualified expenses, subject to income tax and the 10% penalty on earnings.

New provisions in the latest SECURE Act allow unused 529 assets to be rolled over into a Roth IRA for the beneficiary if certain conditions are met. To qualify the 529 plan must have been in place for at least 15 years. The transfer amount cannot exceed the contributions and earnings that were in the 529 account five years prior to the transfer. There is an aggregate limit of $35,000 for the total amount that can be transferred, and the rollover amount counts towards the beneficiary's Roth IRA contribution limits.

Conclusion:

Understanding the process of withdrawing funds from a 529 plan is essential for parents and grandparents alike. Whether you have a parent-owned or grandparent-owned 529 plan, knowing how to reimburse yourself or pay the school directly can help you maximize the benefits of this valuable college savings tool. Additionally, staying informed about qualified expenses and FAFSA considerations ensures that your withdrawals are made in the most advantageous and responsible manner. With careful planning and proper documentation, you can confidently navigate the withdrawal process and provide financial support for your child's education.

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The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by GW Financial, Inc. to provide information on a topic that may be of interest. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright 2023 GW Financial, Inc.