Matching 529 distributions to qualified expenses

So Junior is off to college and now it’s time to start paying the bills. For those who have done a good job putting money away in a 529 account, it’s important that you time your distributions in the same year as your expenses. It’s time to learn about two forms: the 1099-Q and the 1098-T.

The 1099-Q reports your withdrawals from a qualified tuition program such as a 529 or Coverdell ESA in a calendar year. The 1099-Q goes to the person who received the withdrawals. So if the withdrawal went to you, the parent, then you will receive the 1099-Q. If the withdrawal went to the student, then the student will receive the 1099-Q. (See my previous post about why you would want withdrawals going to either the student or parent.)

The 1098-T is provided by the college and details qualified tuition and related expenses for the year. The 1098-T is issued to the student, regardless of who pays the tuition. Check with your school to see what exactly is on the 1098-T. Typically room and board expenses, even if paid to the school, are not, though those are qualified higher education expenses.

IMPORTANT: The 1098-T can show either amounts billed or amounts paid. If the amount is in Box 1, then it’s the amount paid. If it’s in Box 2, it’s the amount billed. Your distributions can only be used for amounts paid. So if you receive a bill in December that is due in January, wait until January to take the distribution from your 529 account. If your withdrawals exceed your expenses paid, then you’ll be subject to tax and the 10% penalty.

Many schools offer the opportunity to prepay all four years of tuition in order to lock in current rates. This can be a good deal, but beware the consequences of withdrawing the full amount from your 529 plan. Most schools still only credit you each year’s tuition expense annually, even if you prepay. If that is the case, then you need to come up with other money to prepay the tuition and then reimburse yourself annually from the 529 plan. Otherwise, you might pay  a 10% penalty to achieve a 7% savings. Check with your school if they make this offer.

And don’t forget, you can’t double-dip on tax benefits. What that means is, if you plan to take the American Opportunity or Hope tax credit, you need to pay some of your qualifying expenses with cash flow, not 529 plans. You can’t use tax-advantaged funds to pay for something and then also take a tax deduction for the payment. Here is more info on the AOTC and Hope tax credits.

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