You Have 529 Questions, We Have Answers
We set the record straight on reader questions about 529 distributions and financial aid.
From time to time, we like to dip into our mailbag and answer reader questions about 529 college-savings plans. Here's the latest batch:
Question: Can you use a 529 account to cover college-application costs and the cost of visiting colleges?
Answer: The 529 rules (found under the Qualified Tuition Program section of IRS Publication 970) list the following as qualified expenses: tuition, fees, books, supplies, equipment required for attendance, room and board (for students enrolled at least half-time), and, if applicable, costs associated with special-needs services. (A bill approved by the U.S. House of Representatives and awaiting a vote by the U.S. Senate would add computers to the list.) Application fees and costs associated with visiting a school are incurred prior to enrollment and, therefore, are not considered qualified expenses, according to Mark Kantrowitz, senior vice president and publisher of the college-planning website Edvisors.com.
Question: If I fund a Roth IRA for a 16-year-old relative, will the assets hurt his financial-aid eligibility?
Answer: It depends. If the student will be filling out the Free Application for Federal Student Aid, or FAFSA, retirement assets are excluded from the calculation, meaning assets held in a student-owned IRA would not affect eligibility. However, the CSS/Financial Aid PROFILE form used by some private colleges does ask about student and family retirement assets. So, if the student plans to apply to private colleges that use this form, it is possible there would be a negative financial-aid impact there.
Another important consideration is whether the student plans to use assets from the Roth IRA to help pay for college. If so, withdrawals from the Roth IRA--even if only the contribution portion of the account is withdrawn and no taxes are owed--count as student income on the following year's financial-aid application. So, I would recommend against using the Roth IRA for this purpose unless the money is to be withdrawn to help pay expenses during the student's final year in school, when applying for financial aid the following year is no longer a concern. (For more on the pitfalls of using a Roth IRA to save for college, click here.)
Last but not least, keep in mind that the student can only contribute to the Roth IRA up to the amount of his earned income for the year; nor can Roth IRA contributions on his behalf exceed his earned income. So, if he has only earned $3,000 over the course of the year, that's the limit on his IRA contribution.
Question: My daughter is attending a year-abroad program. Can we use our 529 account to pay room-and-board costs, and are they subject to the school's cost-of-attendance figure?
Answer: As long as the program allows the student to earn credit from a college that meets the 529 qualifications--that is, one eligible to participate in the federal student-financial-aid program--529 disbursements may be used to pay for qualified expenses. So, if your daughter takes part in a year-abroad program for which she will receive credit at a qualifying U.S. college, then, yes, you can use 529 assets to pay for those expenses, including room and board.
Qualifying room-and-board expenses usually are limited to the amount used by the school in calculating the cost of attendance for financial-aid purposes. However, Kantrowitz says the student's home college typically will adjust the cost of attendance for any added costs associated with the study-abroad program.
Question: Can you use a 529 to pay for vocational school and other training programs?
Answer: Yes, you can, as long as it's a postsecondary school that is eligible to participate in the federal student-aid program. You can search for specific schools by name or location by using this search tool on the U.S. Department of Education's website.
Question: My son, a college junior, is the beneficiary of a Florida 529 account and has not used any of the $120,000 I invested for him in the plan, as he has a full scholarship. Can we withdraw the tuition and room-and-board money equal to the scholarship without penalty? If so, can we do it retroactive to his freshman year?
Answer: When a 529 beneficiary receives a scholarship, assets equal to the amount of the scholarship may be withdrawn from the account without penalty, but only for any tax-free portion of the scholarship. This typically includes tuition and fees but not room and board. So, if you take out 529 assets to cover the room-and-board portion of your son's scholarship, a 10% penalty for nonqualified distributions would apply.
However, whether the scholarship is tax-free or not, any 529 distribution you take to offset it will mean paying taxes on the earnings portion of the withdrawal (no taxes are owed on the contributions portion). Taxes may be paid at your rate or your son's rate if the money is distributed to him. The 10% penalty is added to the amount of taxes owed.
One way to avoid paying taxes or a penalty would simply be to keep the money in the 529 account in case your son decides to attend graduate school at some point, or you could roll the money over into a 529 established for the benefit of a sibling, cousin, or other member of the extended family. Whatever you decide, the 10% penalty is only waived if the money is withdrawn during the same year the scholarship expenses were incurred, so you may not do so retroactively to your son's freshman year.