A 529 plan provides a tax saving advantaged to encourage saving for future education costs. 529 plans, also known as “qualified tuition plans” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. Contribution in a 529 plan may offer special tax benefits. These benefits vary depending on the state and the 529 plan. State and federal laws that affect 529 plans could change. Taxpayers should make sure they understand the tax implications of investing in a 529 plan and should consult with a tax advisor.
The big advantage of 529 plans is that qualified withdrawals are always federal-income-tax-free, and usually state-income-tax-free too. Taxpayers should know that not all 529 withdrawals are tax-free qualified withdrawals, even in years when you have heavy college costs.
There are six important points to know about 529 plan withdrawals. In this part 1 of part 2, we will highlight three of them.
1. You Usually Have Several Payment Options
In the case that you are the 529 account owner or plan participant. Plans commonly use both terms to describe the person who established and controls the account. As the account owner, you can generally have a withdrawal check cut in your own name or have an electronic deposit made into your own account. Alternatively, you can have a withdrawal issued in the name of the account beneficiary, the college student for whom you set up the 529 account, usually a child or grandchild, or issued directly to the educational institution for the benefit of the account beneficiary. You choose your payment option by submitting a withdrawal request to the 529 plan.
2. Watch Out for Withdrawals from 529 Accounts Funded with Custodial Account Money
When you funded the 529 account with money that came from a custodial account that was set up for the account beneficiary, your child or grandchild, under your state’s Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA), you must use any money taken from the custodial account for the benefit of the child or grandchild. You cannot take a 529 account withdrawal for yourself when the 529 account was funded with money from a child’s or grandchild’s custodial account because the money in the 529 account came from the custodial account. The 529 account money legally belongs to your child or grandchild, not you. However, if you funded the 529 account with your own money, the money in the account is fair game. You can take withdrawals and do whatever you want with them, subject to the potential federal income tax implications explained later.
3. The IRS Knows about Withdrawals
For any year that a 529 withdrawal is taken, the plan must issue a Form 1099-Q, Payments from Qualified Education Programs, under Sections 529 and 530, by February 1 of the following year. If the withdrawal goes to the 529 account beneficiary, your child or grandchild, the 1099-Q goes to him or her. If the withdrawal goes to you as the account owner, the 1099-Q goes to you. Either way, the IRS receives a copy.
Further reading:
IRC section 529.
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