What to Know About Reimbursements From 529 Plans

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Question: My son will be starting college in Maine this fall, and we’ll withdraw money from his 529 plan for the first time. Do we need to provide the college-saving plan with evidence of eligible expenses before we can access the money? Also, is there anything special we need to do at tax time?

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Answer:

You don’t need to provide the 529 plan with evidence that you will be using the money for eligible expenses, but you do need to keep the receipts, canceled checks and other paperwork in your tax records (see When to Toss Tax Records for more information), in case the IRS later asks for evidence that the money was used for qualified expenses. You can withdraw money tax-free for tuition, required books and fees, and even a computer and related software. You can also take tax-free withdrawals for room and board (whether in an on-campus dorm or off-campus housing), as long as your son is a student at least half-time.

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You can pay the bills and then reimburse yourself from the 529. The plan may send you a check or deposit the money directly into your bank account. Vanguard, for one, will send funds to account owners by electronic bank transfer if they provide their bank account information. Or the plan may send a check directly to the school. “We can send a check to the account owner, the student or the school. We are not able to send funds to a third party, such as an apartment complex or landlord,” says Char Gross, principal and head of Vanguard’s Education Savings Group. But don’t wait too long to withdraw the money, she says. “Account owners must reimburse themselves in the same calendar year the expenses were incurred.”

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Ask your plan whether your state requires any special documentation. “Some states may have unique reporting requirements if they offer state tax deductions, credits, matching grants or other programs,” says Brian Boswell, of Savingforcollege.com.

The 529 plan administrator will send you Form 1099Q by the end of January for any withdrawals taken in the previous calendar year. If the withdrawals are made by the account owner, the 1099Q will be in the account owner’s name. If the withdrawals are sent to the beneficiary or the school, the 1099Q will be in the beneficiary’s name, says Gross. “No action is needed on the 1099Q for withdrawals that were used for qualified education expenses.”

Be particularly careful about documenting eligible expenses if you also claim the American Opportunity Credit, says Boswell. The American Opportunity Credit is worth up to $2,500 for each of the first four years of college and is based on 100% of the first $2,000 spent on qualified education expenses (tuition and fees) and 25% of the next $2,000 spent on eligible expenses for each year. To claim the maximum credit, you’ll need to have $4,000 a year in eligible expenses. You can’t double dip tax breaks, so you can’t use 529 money for the same expenses. But you may have plenty of other expenses that qualify for tax-free 529 withdrawals. Keep in mind, for example, that in addition to any extra tuition costs and required books and fees, room and board is eligible for 529 withdrawals but not for the American Opportunity Credit.

For more information about the American Opportunity Credit and 529 tax rules, see IRS Publication 970, Tax Benefits for Education (see the Qualified Tuition Program section for more information about 529 plan rules).

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As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.