Client Question: What is the Best Way to Take a 529 Plan Distribution?

June 24, 2014

Q: As the owner of a 529 plan for a student beneficiary, is it better to pay college expenses and take a distribution from the 529 plan as reimbursement, or have the beneficiary take a distribution for college expenses they incur?

A. There are generally three options for distributing money from a 529 plan for qualified college expenses. First is a distribution to the account owner. Second is a distribution to the student beneficiary. Third is a payment directly to the school.

According to Joe Hurley, founder of the website, www.savingforcollege.com, payments made to the student beneficiary may wind up being the best option, as the resulting Form 1099-Q is then issued in their name and social security number. As long as the expenses qualify and are equal to, or less than the distribution amount, the transaction is tax-free and does not need to be reported on the Form 1040. However, if expenses are lower than the distributed amount, having the money distributed to the beneficiary means that earnings will then be taxed at the student’s rate, unless the “kiddie tax” applies. Note that if qualified expenses are lower than a distribution as a result of scholarship money, the excess distribution is not subject to the usual 10% penalty.

If, on the other hand, a distribution is made to the account owner, the Form 1099-Q is issued with the account owner’s name and social security number. Since the form notes the distribution was not made to the beneficiary, the IRS is likely to require proof of qualified expenses to justify the distribution and subsequent exclusion of earnings from taxation. The end result is the same, but there may be more paperwork involved to get there.

Distributing 529 plan assets directly to the school is another option that may provide complications. In the event that a student beneficiary has a needs based financial aid package from the school, a direct payment from the 529 plan may be treated similar to an outside scholarship, reducing the amount of the school’s award. It is important to verify the financial aid policies of each school before deciding whether to pay college expenses directly from a 529 plan.

No matter which distribution method you choose, keep good records and documentation for qualified education expenses. For more information on 529 plan distribution options, please feel free to contact us.

 

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This report has been prepared by West Financial Services, Inc. from original sources and data we believe to be reliable. This report is for informational purposes only and should not be construed as investment, legal or tax advice. Analysis of past market conditions may not predict future market activity.