Owner versus beneficiary
There are two parties to any 529 plan account: The account owner, who has control over the account and can name the beneficiary to the account, and the beneficiary (the student). The account owner can change beneficiaries on the account and can even name themselves as the beneficiary. One can name anyone as the beneficiary (e.g., child, friend, relative, yourself). You can be proactive by creating an account and naming yourself the beneficiary now, before switching to your child in the future. The account owner can live in one state with the beneficiary in another and invest in the 529 from a third state, and the student may eventually go to an educational institution in a fourth state. The 529 education savings account is not limited to any specific college, as a prepaid plan may be.
Withdrawals from 529s
If a 529 account withdrawal is for qualified higher education expenses or tuition for elementary or secondary schools, earnings are not subject to federal income tax or, in many cases, state income tax. Qualified withdrawals need to take place in the same tax year as the qualified expense.
Withdrawals not used for qualified higher education expenses in that year are considered “nonqualified” and would be subject to tax and 10% penalty on the earnings. State and local taxes may apply as well.
You can use the proceeds from the account free of taxes for the following qualified higher-education expenses:
- Tuition and school fees for both full and part time students at an eligible college, university, trade, or vocational institution.
- Room and board if the student is enrolled at more than half-time status. The amount up to the school’s room and board charges are eligible if paid directly to the school or to a landlord if living in nonschool housing. If actual charges to the landlord exceed the schools’ charges, then the amount above the school’s charges would be considered an excess withdrawal.
- Required books, supplies, and equipment for the academic program. Computer and technology equipment, printers, and required software, and such related services as Internet access also are qualified expenses.
- Private elementary or secondary school tuition up to $10,000 annually also is a qualified expense for 529 withdrawals.
Health insurance for the student and transportation-related costs to and from the school are not qualified expenses.
Contributions and fees
Like all investments, the fees associated with a 529 account need to be considered, as excess fees lower the investment returns. Prepaid tuition plans may charge initial application, transaction, and ongoing administrative fees. Investment 529 accounts may also have administrative costs such as program management fees, per-transaction fees, and the underlying investment expense ratios. Some states have broker-sold plans as well as direct-sold plans. Broker-sold plans can be purchased only through a broker and have the additional expenses associated with that either in the form of a load (sales charge) or higher expense ratio.
