When you withdraw the money from your 529 plan, you should use it on education expenses in that same calendar year. Otherwise, you'll be making an unqualified withdrawal that will cause the IRS to take notice, since you won't be using the funds immediately. Be sure to keep any receipts, should the IRS request information.
The 529 plan has two major types: a prepaid tuition plan and an education savings plan. They each serve different needs and offer different investment methods.
Education savings accounts can be invested in many different assets, including potentially high-return options, such as stock funds and the like, as well as lower-return but less risky options, such as bond funds and even money market funds. If it's invested in the market, however, such as in stock funds or bond funds, its value is not insured by state or federal governments.
The 529 plan can offer several tax and financial aid benefits to participants:
It's possible to use a single 529 plan for the benefit of multiple children. For example, if your children's ages are more than four years apart, you may be able to change the plan's beneficiary after the first child graduates. If you do this, however, you might want to factor in how much money is left in the plan for the second -- or third -- child once it's been tapped by an earlier child.
Using just one plan may also make the 529 plan less valuable for later children. For example, if you switch to more conservative investments as the first child nears college, then it may deprive the second child of potential future returns from more aggressive investments depending on how it's allocated.
Depending on your situation, it may make more sense to have a separate 529 plan for each child and account for the total cost of college. This approach also allows you to keep better records and may offer you an additional chance for a state tax deduction if your state offers one.
It's important to understand that you can only access your money on a tax-free basis if you spend it on qualified education expenses. Anything that doesn't fit the IRS' interpretation of a qualified expense will likely see the agency slapping a penalty on your withdrawal.
Anything not specified by the IRS in its definition of a qualified expense is likely not covered.
If the funds are being used for higher education, the IRS specifies that qualified expenses must be "related to enrollment or attendance at an eligible post-secondary school." Moreover, the IRS says that "to be qualified, some of the expenses must be required by the school and some must be incurred by students who are enrolled at least half-time."
Eligible expenses include:
You will not be able to use a 529 penalty-free to pay for transportation costs at college or extracurricular fees.
If you're looking to open a 529 plan, you can do that directly through a state plan. But you also have the option of going through a broker or financial advisor who may be able to assist you with the plan.
Both Fidelity Investments and Charles Schwab allow customers to open 529 plans, so they may work especially well if you already have accounts with those companies.
A 529 savings plan can be used at any qualified college nationwide. Most states do not limit the availability to states that sponsored your 529. For example, you might contribute to an account set up with one state's plan, but still be able to use the funds at any qualified institutions of higher learning.
Prepaid tuition plans, on the other hand, are often more limited in scope. They can usually only be used at specific colleges. Some state prepaid tuition plans allow for the credits to be used at multiple public institutions in the state, but you might not be able to use the credits outside the state.
Double-check to see that your institution qualifies, however, since not every college does.
If your child opts not to go to college or a vocational school, the beneficiary can be changed to another family member who might be able to use the money. In general, the plan can continue holding the funds indefinitely as long as it has a living beneficiary listed.
As mentioned above, if the plan has been open for at least 15 years, the funds can be rolled over to a Roth IRA for the beneficiary, with the amount capped at the IRA's maximum annual contribution limit. This provision has a lifetime cap of $35,000. You'll have to pay taxes on the earnings, as well as a 10 percent penalty.
However, there are ways to get the money back without paying the 10 percent penalty, although you may need to pay taxes on earnings.
There are many benefits to establishing a 529 plan. The money is allowed to grow tax-deferred and funds can be withdrawn tax-free for qualified expenses. And if unused, the money can now even help repay student loans or be rolled into a Roth IRA.
To make the most of a 529 plan, you'll need to fully understand how to use the funds properly, including knowing what is and is not covered. Talk to a financial advisor for guidance if you're not sure whether a 529 plan is right for your family.