Millions of parents invest in 529 plans to pay for their children's college educations. But when it comes time to pull the money out, be aware that not all the expenses Junior incurs on campus will qualify for the tax-free treatment that makes these state-sponsored college-savings plans so valuable.
Are These Qualified 529-Plan Expenses?
Not all college-related costs qualify for tax-free withdrawals under 529 rules. Take our quiz to see if you know which ones qualify.
Withdrawals from 529 plans are tax-free only if they are used to pay for so-called qualified higher-education expenses, as defined by the Internal Revenue Service. These include tuition and other fees required by the university, as well as room and board for students enrolled at least half time. Course requirements such as books, calculators and software are included, as are services for special-needs students.
If a parent takes out money for anything that doesn't meet the "qualified expense" criteria, the earnings portion of that distribution will be taxed as ordinary income and could incur a 10% federal penalty.
That applies to discretionary college costs, like those associated with intramural sports teams or sororities and fraternities, as well as transportation expenses, such as gas for those who commute to school or airfare to fly a student home for the holidays.
Although most parents probably don't have enough money in their 529 plans to cover anything but tuition costs, it pays to know the rules. A laptop, for instance, isn't considered a qualified education expense unless it is required by the college or for a course. While room-and-board costs generally qualify, must-haves for the dorm, like the bed sheets and a mini-fridge, don't, unless they're charged to the student by the university. Off-campus housing gets the green light, provided rent and food don't surpass the estimated off-campus expenses published by the university. If they do, the difference isn't considered a qualified expense.
Some college-savings experts suggest that in certain cases parents might be able to challenge what counts as a qualified expense.
For example, students with a partial meal plan might be able to argue that the money they spend on off-campus food equal to the difference in cost between the partial and full meal plan should get the favorable tax treatment, says Joe Hurley, founder of Savingforcollege.com, which tracks 529 plans.
Likewise, buying a health-insurance policy from a college generally isn't a qualified expense but a parent might have an argument if the college requires all students to have coverage as a condition of enrollment, says Andrea Feirstein, managing director at AKF Consulting Group, which advises states that administer 529s. Parents should consult with a tax adviser.
Ms. Andriotis is a senior writer for SmartMoney.com. She can be reached at email@example.com.