College finances can be confusing. Tax-free 529 plans, student loans and financial aid all need to be considered when strategically planning to pay for a college education.
A new parent’s best friend is the tax-advantaged 529 college savings account. Starting to save when children are very young reaps the benefit of time. But when you are ready to use those funds, many questions arise. A Wall Street Journal article, “Can You Use the ‘529’ Money for Grad School?” covers many of the most commonly asked questions.
Here are some of answers:
Grad School Use. Yes, 529 funds can be used for graduate school.
An Unused 529. If a child receives a scholarship, you’re allowed to withdraw that amount from a 529 without any penalty. But if that money isn’t used for educational expenses, there is income tax liability on any earnings. In the event a child who graduated several years ago still has money in her 529 account because of a large scholarship in college, the owner can still withdraw the amount of the scholarship from the 529 account without paying tax or penalty. However, there will be income taxes on any earnings. There’s no requirement that you withdraw money from the 529 in the same year you receive a scholarship, but it’s a good idea.
Change of Beneficiary. You can change the beneficiary to any direct relative of the original beneficiary and this can be done at any time.
Estate Planning. To find out how ownership transfers work with your estate plan, you should talk to an experienced estate lawyer, as 529 plan rules can differ. Some plans let you name a successor owner or contingent account holder. At death, ownership would transfer to that person. There is an exception where the parents have made a five-year lump-sum contribution to “superfund” a 529 plan and avoid paying federal gift taxes. In that instance, if the parents die before the end of the five-year period, there could be estate taxes.
Gift-Tax Exclusion. Instead of using a 529 account, a grandparent could use the gift-tax exclusion to help grandchildren pay for college expenses. You’re permitted to give a grandchild (or anyone else) up to $14,000 a year without having to file an IRS gift tax form. You can also pay the school directly without gift tax consequences. However, some institutions will deem this type of payment to be student support. That can mean a dollar-for-dollar reduction in aid eligibility when the student applies for financial aid in the coming year. Note that the gift-tax exclusion for direct payments to colleges only covers tuition, but withdrawals from a 529 account can also cover qualified educational expenses like computers, room and board, and books. Another thought is to contribute to the student’s 529 plan, which is assessed at a lower percentage than student income in the financial-aid calculation—this will have less of an impact on aid reduction.
Make sure that you are very clear on whether or not the withdrawals are deemed “educational expenses.” If a withdrawal does not qualify as educational, there will be tax liabilities. Note that what is deemed qualifying does change over time. Not too long ago, computers were not considered a qualified item! Also, speak with both the college (usually the bursar’s office) and the mutual fund company managing the 529 to learn how they distribute money to the college. The disbursements may not be as prompt as a transfer from a large bank.
Reference: The Wall Street Journal (October 8, 2016) “Can You Use the ‘529’ Money for Grad School?”