With multiple 529s, which to spend first?


Dear Joe,

My child's grandmother and great aunt each have a 529 plan for her college expenses. What expenses for college are covered and what paperwork (receipts) do we need to record or keep? Is it going to be a problem having two 529 accounts?

-- Roxanne

Dear Roxanne,

It's fairly common for multiple family members to set up their own 529 plans for a particular child. Parents, both sets of grandparents, and aunts and uncles may all have a desire to help pay for the child's college education.

By retaining ownership of their own 529 accounts -- as opposed to making contributions to your parent-owned account, the other family members remain in control of their college investments. They have the right to change the beneficiary designation to a different family member, and they can even decide to pull the money back out for themselves, subject, of course, to tax and a 10 percent penalty on any distributed earnings.

In your situation, the problem comes down the road when your child enters college, and the 529 funds are needed to pay her expenses. Whose money is to be used first, grandma's or auntie's?

Quite possibly, it will be up to you as gatekeeper to make that decision. You could invite one to pay for tuition and fees, and the other to pay for books, supplies and room and board. Or perhaps, one will help fund freshman and junior years, and the other will fund sophomore and senior years. Of course, the decision must be based in part on the total amount of money in their respective accounts, and how that total compares to your child's qualifying college costs.

Account owners can request that the 529 plan make distributions payable to the school, to your child as beneficiary or to themselves as reimbursement for costs they pay using other funds. Typically, I recommend making the distribution payable to the beneficiary who can then use that money to pay his or her expenses. This approach often helps to avoid certain tax and financial-aid complications.

You do not have to trace the distributions directly to the payment of qualified higher education expenses such as tuition, fees, books, supplies, equipment, and room and board. As long as total qualified expenses paid during the year equal or exceed the total distributions for the same calendar year, the distributions are tax-free and do not have to be reported on the recipient's income tax return. But you will need to retain receipts as evidence of those payments in the event of an IRS examination.

At some point, your daughter's grandmother and great aunt may decide they no longer want to be account owners and will request that the 529 plan administrators transfer ownership to you. This can certainly make your job easier when it comes time to tap those accounts, since you will then have total control. Beware: A few 529 plans do not accept requests to transfer ownership. The only way to accomplish it may be to roll it into a more accommodating 529 plan first.

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