529 plan savings not enough for four years of college? Here's how parents can make their money go further
Many parents save money in a 529 plan because it offers tax benefits for education expenses. The money in a 529 plan grows tax-free, and withdrawals can also be tax-free if used for approved education costs. However, many families find that their 529 savings do not cover the full cost of college because tuition, housing, and other expenses have increased over time.
An underfunded 529 plan is not a failure because it can still help reduce a large part of college costs, as per the report by Kiplinger. The main benefit of a 529 plan is that withdrawals are tax-free when used for qualified education expenses.
Qualified expenses generally include tuition, mandatory fees, books, required supplies, computers, internet access, and room and board for students enrolled at least half-time.
529 plan rules
Room and board expenses have limits, especially for students living off campus. The limits are usually based on the school’s official cost of attendance. If the account balance is limited, families may want to use 529 money first for tuition and required fees because those expenses are easy to document and provide the strongest tax benefits.
Using 529 funds for expenses that are not approved can lead to income taxes and penalties on the earnings portion of the withdrawal, as noted by Kiplinger.
IRS withdrawal rules
The IRS says families can also use up to $10,000 per year from a 529 plan for tuition at public, private, or religious elementary and secondary schools. One of the most common mistakes families make is taking money out of the account at the wrong time. The withdrawal and the education expense must happen in the same tax year. An example shared by Kiplinger, paying tuition in January and taking money out in December, or doing the reverse, could create tax issues.
Also read: Federal student loan rules changes: Here’s what SAVE, Parent PLUS and graduate borrowers need to know before July 1
This can be confusing because many colleges send spring semester tuition bills in December even though classes begin in January. Families should make sure the payment and the withdrawal happen during the same calendar year to avoid problems. Keeping all tuition bills, housing invoices, receipts, and payment records for tax purposes, as suggested by Kiplinger report.
College cost planning
Families should not automatically spend all their 529 money during the first year of college. College costs often rise over time, so spreading withdrawals across all four years may be a better strategy. Some parents intentionally save part of the account balance for later years when scholarships may decrease or housing costs may increase.
There is no single correct way to use a 529 plan, but families should avoid exhausting the account too early, as noted by the Kiplinger report. Most families pay for college using a mix of 529 savings, current income, scholarships, financial aid, savings, and student loans. Limited federal student borrowing can sometimes be a reasonable option if it helps families use their 529 funds more effectively.
Ways to pay college
Paying some college expenses from current income may allow the remaining 529 money to keep growing tax-free. Future financial security should be prioritised over paying from retirement funds for expensive college education. Education is important, but parents should also protect their long-term financial health. As per a report in Kiplinger, the 529 plans curated for parents are counted as assets and gain favour during the financial aid allocation.
Regular withdrawals though can impact the eligibility for financial aid depending upon who owns it, and 529 accounts owned by elderly should be specially monitored. Recent FAFSA changes have reduced some financial aid penalties related to certain 529 withdrawals, but careful planning is still important.
Extra 529 plan options
Many people do not realize that 529 plans can also be used for some vocational programs, apprenticeships, certification programs, and limited student loan repayment. If money remains in the account after college, families do not have to rush to spend it. The remaining funds can be used for graduate school. The account can also be transferred to another eligible family member if needed.
Under current rules and limitations, some unused 529 funds may also be rolled into a Roth IRA for the beneficiary. This flexibility gives families more options and reduces pressure to spend every dollar during college. The report by Kiplinger states that families who carefully plan withdrawals, use qualified expenses, and combine the 529 plan with other funding sources can often make their education savings go further than expected.