College Savings Timeline: Time for college

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It’s hard to believe that mid-July is already here. Your child’s high school years are officially over and they are left with fond memories and lasting friendships. Tears of pride and happiness were shed at their graduation ceremony, and friends and family joined together to celebrate the accomplishment. Now it’s finally time for the next stage in life – college.

You’ve been diligently contributing to a 529 college savings account for years, but what happens when the first tuition bill is on the way?

1. Make your 529 withdrawals.

We understand that it may not be easy, but eventually you are going to have to take money out of the college fund you’ve been working so hard to build. On a more positive note, unlike other investment accounts earnings in a 529 plan will not be taxed when they are withdrawn as long as the money is spent on college expenses. To lock in your tax benefits, be sure to take out the maximum amount in your account that will qualify for tax-free treatment.

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2. Make the distribution payable to the account beneficiary

Okay, so how exactly do you withdraw the money to pay for college? Most 529 plans offer the option of making distributions payable to the account owner, the beneficiary, or the school. Designating the beneficiary as the recipient sometimes prevents unfavorable income tax and financial aid surprises. Some plans allow account owners to request withdrawals online to be deposited into their linked bank account. If this is the case, simply write a check to the student after the deposit clears.

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3. Pay for qualified expenses

Why is this so important? Well, if you haven’t heard, in addition to paying tax on earnings, there is a pesky 10% penalty tax that you’ll incur on the earnings portion of your account used to pay for non-qualified expenses. The principal portion, which is made up of the money that you put in, will not be taxed since contributions are made with after-tax dollars. For most students attending college this shouldn’t be an issue since qualified expenses include tuition, books, supplies and equipment required for enrollment, adaptive equipment for students with special needs and even room and board as long as the student is enrolled at least half-time.

A common question from parents is whether or not computers, tablets and Internet access are considered qualified expenses. These are pretty big purchases and it could be argued that they are necessary to be successful in college. However, in the eyes of the IRS, technology must be required for enrollment or attendance at an eligible institution to be considered a qualified expense for 529 purposes. Be sure to check with your school to find out their specific requirements before assuming an expense is qualified.

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4. Keep making contributions to your 529 account

Don’t stop now - you’re on a roll! You can still benefit from saving with a 529 plan even if your child has already started college. If your child is a freshman, you could have four more years of tuition and expenses to pay for. With a 529 plan, you’ll pay less in federal taxes than with other savings vehicles, and you can still collect state tax deductions and credits if they are available.

One of the many reasons we love 529 plans is that it’s easy to change the beneficiary. So if your child finishes college with funds left in the account, you can change the beneficiary to a younger sibling (or anyone else planning to attend college) with no tax consequences. The extra savings can also be used to pay for the original beneficiary’s graduate school, or for parents who want to go back to school. Some families even pass 529 savings down to future generations.

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5. Claim the American Opportunity Tax Credit

Under current tax laws, a parent or student can claim a maximum tax credit of up to $2,500 each year for up to four years when paying college tuition and satisfying enrollment and admissions fees. Keep in mind that when you are calculating your qualified education expenses, you must subtract the amount of tuition expense that was used to generate the American Opportunity Tax Credit to avoid double dipping.

From our Family Guide: Federal Tax Incentives Target to Education