By Naomi Gerbatsch (with content from Andy Biebl)
529s are a popular and effective way for people to invest funds ahead of time to cover their dependent’s future higher education costs. These plans are state-sponsored, with each state pairing up with one or more investment institution to offer investment alternatives. The primary feature of a 529 plan is that the investments grow tax-free, and can be extracted tax-free if spent for the beneficiary’s higher education costs.
Congress recently made three improvements to the rules governing 529 plans. These enhancements affect 529 plan disbursements during college years.
- Computer and Technology Costs: The legislation expands the definition of qualified higher education expenses to include computer or peripheral equipment, software, and internet access if the technology is to be used primarily by the beneficiary during higher education years. Previously, computer and technology expenses were only qualified for tax-free 529 plan reimbursement if the technology was required for enrollment or attendance at the school.
- Per Account Tax Treatment: Many students will approach college with multiple 529 accounts because parents and grandparents have separately established plans for the student. In the past, all 529 plans of a beneficiary were aggregated as if one account, for the purpose of determining the amount of income associated with a distribution not properly expended on higher education costs. But this aggregation rule has been repealed, meaning that an excess withdrawal looks only to the specific 529 account to determine the amount of taxable income. If a student has funds in various 529 accounts, there are obvious strategies. College tuition and other qualified costs should be covered by those 529 accounts with the highest appreciation or earnings; nonqualified costs such as a vehicle or other transportation expenses should be drawn from the 529 account with the lowest income or gain.
- Refund of higher education costs: In some cases, after payment of tuition and other higher education costs using a 529 account, the student may receive a refund from the school. For example, assume a student wins a last-minute scholarship that is paid directly to the school, and as a result the school reimburses previously paid tuition. Or perhaps the student withdraws from a class and receives a tuition refund. In the past, if that tuition had been paid from a 529 account, the effect was that an excess distribution occurred because a 529 withdrawal was not fully consumed by college costs. The tax law now allows the family to place the tuition reimbursement back into the 529 plan within 60 days of receipt in order to avoid a taxable distribution.
How we can help
These enhancements make 529 plans even more attractive than in the past. For all of your 529 questions, please contact Naomi Gerbatsch at 425.629.1953 or firstname.lastname@example.org.