5 Tips for Maximizing Your 529 College Savings Plan

In 2022, 33% of students utilized funds from a 529 plan for their college expenses¹. The reason behind this is straightforward: A 529 is a valuable financial planning tool that helps individuals save for higher-education expenses for their loved one. It’s cost-effective, easy to implement, and permits tax-free growth of funds when used to cover qualified educational expenses. But some of the college savings plan’s other benefits may not be as well known.

Whether you’ve already established a 529 plan, or are considering one, here are five insightful tips to help maximize its benefits.

Tip #1: Beneficiary flexibility

529 college savings plans are extremely flexible. With one account holder — a parent, friend, or other relative — and one beneficiary (the prospective student), you have the liberty to transfer funds tax-free to another qualifying family member or adjust beneficiaries as needed. Who is a qualifying family member? It’s an expansive list that ranges from siblings to nieces, nephews, and cousins, and even parents who may have a desire to go back to school.

Example: Mary funded her two kids’ 529 accounts with equal amounts. As most parents know, however, kids can be as different as night and day. Her daughter pursued an engineering degree at an excellent, but pricey, private university. Her son enrolled in a very reasonably priced state university. She needed more money, he needed less. When her daughter didn’t have enough money to pay for an unexpected fifth year of engineering studies to graduate, Mary asked the 529 plan to transfer money from her son’s account to her daughter’s.

Tip #2: The off-campus room-and-board calculation

Beyond traditional expenses like tuition, fees, books, and on-campus housing, 529 funds can cover off-campus rent and related expenses, provided the student maintains at least half-time enrollment.

Have your student track expenses on a worksheet and send it to you every quarter. That way, you have a written record for tax purposes and will know which expenses have already been reimbursed. The total calculation may include rent, food, utilities, and other expenses that would normally be covered as room and board if your student lived on-campus. In addition, reimbursable expenses cannot exceed the room-and-board costs as calculated by the school. You can usually find those costs by searching online on the college’s website or by calling its financial office.

Tip #3: The $10,000 loan repayment

If you end up with unused funds after graduation, consider using the funds to make a payment to a student loan. Authorized under the 2020 SECURE Act, you are allowed to make tax-free 529 withdrawals of up to $10,000 per beneficiary to pay off college loans. Both federal and private student loans are covered.

This is an ideal way for account owners to use leftover 529 funds and help recent graduates lighten the student debt load. Just remember that the $10,000 lifetime maximum applies per beneficiary. Siblings are entitled to their own separate $10,000 lifetime limit.

Tip #4: The retirement plan

Another way to use unused funds, and included as a provision in SECURE Act 2.0, is to roll over the funds into a Roth IRA tax-free. This strategic move kickstarts retirement savings for recent graduates, leveraging tax advantages for long-term financial growth.

To qualify, the 529 must be open for at least 15 years before you can make transfers to the Roth IRA without tax penalty and the transfer amount must be from contributions made at least five years before. In addition, the beneficiary has to be the same for the Roth IRA as it is for the 529 plan. The lifetime limit for the contribution is $35,000, and the annual limit is the same as the regular IRA contribution limit. The beneficiary must earn eligible wages less than the transfer amount that year.

Tip #5: Payment protocols

When you withdraw funds from your 529 plan, you’ll need to determine where the payment is sent. There are three main choices:

• Payable to yourself, as account owner. While this is not usually the best option from a tax perspective, as explained below, it may be unavoidable if you’ve already paid the tuition, rent, or other expense and need to reimburse yourself.
• Payable to the beneficiary. Similarly, this would be to reimburse the student for expenses already paid.
• Payable directly to the educational institution.

What’s important to know is that your choice impacts the amount of aggravation you’ll face at tax time. The neatest solution, and one that streamlines tax reporting, is to make payments directly to the school.

Reimbursing the student is typically the next best choice. The student will receive Form 1099-Q at year-end which reports distributions made from the 529 plan directly to the school or to the student. Distributions for qualified expenses are, of course, nontaxable. If there were any nonqualified (taxable) withdrawals, the student will pay any taxes due at their presumably lower tax bracket.

You’ll want to avoid having distributions made payable to you. Payments you receive as the account holder (for example, to reimburse you for expenses you already paid) trigger a Form 1099-Q to you and can lead to IRS inquiries. While your good recordkeeping can prove all expenditures were for qualifying educational expenses and are therefore nontaxable, you may need to spend a few hours corresponding with the IRS which is not the best outcome.

The versatility of your college 529 plan

A 529 college savings plan is an incredibly versatile and powerful financial tool that can help you wisely manage college savings. By applying these tips, according to your situation, you may get more value out of the account. Since plan rules are sometimes difficult to navigate, we suggest consulting with financial professionals who can help with determining the best approach for your family.

If you are not a Mercer Advisors client and want to know more about optimizing a 529 plan and other worthy financial tools, let’s talk.

1.529 College Savings Plan Statistics, BestColleges, January 5, 2023.