My Toolbox: what every parent with a 529 College Savings Account needs to know
You've done everything right - contributed to your child's 529 Plan for college savings, read up on all the rules and articles on what to do and what not to do, and gotten your first tuition bill. But now what? How do you actually manage withdrawals, reimbursements, receipts and accounting? How you keep your records and communicate with your college student can make all the difference and there is no concrete guidance on how to do it effectively. Follow these recommendations and simple methods to make it easier throughout the year, in December, and at tax time.
Disclaimer: this article is not intended for those using 529 plans for high school expenses. The author of this article is not a tax or legal professional. Please consult a tax professional for any questions or to confirm information contained herein.
Understand the rules
The rules of 529 Plans keep changing and evolving. A few years ago, for example, computers, printers, and software such as Microsoft Office were not qualified expenses and now, they are. And, not all university-billed fees are qualified expenses. It is important to check the rules each year.
I recommend going straight to the IRS website or a tax professional to understand the rules and definitions of qualified expenses, as there are a lot of gray areas. One rule that is very frustrating, but clear, is that while colleges and universities are on a school-calendar-year, 529 Plans work on a calendar year. That means you must manage your records across different school years, with different costs of tuition, housing, room and board for each school year, and, most importantly, you cannot withdraw funds in one year for use in different calendar year. The definition of a qualified expense can also be confusing.
Learn how to determine if an expense is "qualified"
A qualified expense is an expense associated with attending college or university that you can use 529 funds to pay for directly or to reimburse yourself. I find it helps to consider all 529 expenses in three categories: university-billed tuition & fees, room and board, and, other qualified expenses:
1. Tuition & fees: for tuition and fees, required fees and tuition billed by the school are qualified expenses. However, optional expenses that are billed through the school, such as health insurance, parking, or student accounts for laundry, are not qualified. A good rule of thumb is that if it's optional, it is probably not a qualified expense, but if it's required, it is a qualified expense. Just because it is on the bill from the institution does not mean it is qualified. Be sure to read the bill carefully.
2. Room and board: there are four scenarios for room and board expenses: a) your student lives on campus, b) your student lives off-campus but in school-affiliated housing such as a fraternity or sorority house, c) your student lives off campus in their own housing arrangement, d) your student lives off campus but eats on-campus through a meal plan.
a) On-campus housing: for on campus room and board plans, all plans are qualified. Expenses for meals and snacks eaten off-campus or on campus but purchased outside of the meal plan are not qualified.
b) Off-campus but in school-affiliated housing: if your student lives in a fraternity or sorority house or other school-affiliated housing and/or is on a meal plan associated with the housing, all billed charges are qualified as long as they are equal to or less than the highest-priced on-campus room and board plan that the school offers and that is published on the school's website. Note: if your student is on a partial meal plan and has to eat out or cook for themselves for the rest of the time (such as weekends, which is typical if you live in a fraternity or sorority house), the cost of those additional meals is a qualified expense as long as the total that your student spends on meals is less than or equal to the highest-priced meal plan offered on-campus. To make this simple, I split the published annual maximum amount in half for semesters or in thirds for schools on the quarter system. You will need to use two maximum amounts - one for the spring (and summer) and one for the fall since the school year changes mid-calendar year and the amount may change in the fall of each year.
c) Off-campus housing and meals: if your student lives in an apartment, shared house, or other living arrangement not associated with the school, the cost of housing and meals is a qualified expense as long as the total amount is less than or equal to the highest-priced on-campus room and board plan. It is important to note that housing also includes the cost of utilities (such as water, garbage, electricity, wi-fi, telephone). This category has the most flexibility with regard to meals and essentially includes meals, snacks, and beverages as long as the total amount spent on rent, utilities, and food is less than or equal to the highest-priced room and board plan published by the campus for that year.
As above, to make this simple, I split the published annual maximum amount in half for semesters or in thirds for schools on the quarter system. You will need to use two maximum amounts - one for the spring (and summer) and one for the fall since the school year changes mid-calendar year and the amount may change in the fall of each year.
If your off-campus student has a car and there is an extra charge for parking, my interpretation of the rules is that parking expenses are not qualified under the 529 plan. Ditto for satellite or cable television. I consider these two to be in the "optional" category, and, therefore, not required. However, if your student's on-campus housing plans include parking and television, then it seems reasonable to include these as reimbursable expenses for housing if your student lives off-campus.
d) Off-campus housing but on-campus meals through a meal plan: all expenses are qualified as long as the total spent is less than or equal to highest cost room and board plan that the school offers. To make this simple, I split the published annual maximum amount in half for semesters or in thirds for schools on the quarter system.
A word about alcoholic beverages: while the IRS says nothing about if alcoholic beverages are qualified expenses or not, a good rule of thumb is that a night out bar-hopping is not a meal expense, so don't raise eyebrows by trying to include it such an expense, even if you are under the expense limit for the quarter or semester.
3. Other qualified expenses: it's easy to argue that there are a lot of other necessary costs associated with going to college, such as travel to campus, and be tempted to include them as qualified expenses, but the current 529 IRS rules permit only a few additional expenses as qualified expenses. These include computers, printers and computer software necessary use (such as Microsoft Office), required textbooks (required means it is in print somewhere), required software or subscriptions for a particular course (again, in print on the syllabus), and anything else required for the course and in print as a required item (such as a lab coat and goggles). So, no, your student's cell phone, iPad, Spotify subscription, campus shuttle or Uber ride to the airport, gas for the car, or airfare is not a qualified expense. But, again, check the IRS website or with your tax professional each year to be see if the rules have changed.
For all expenses for which you use 529 funds, the key to success is to write down your policies and interpretation of the rules and definitions, make sure they are reasonable and defensible in an audit, be consistent, and make sure your student understands them.
Develop a system for managing expenses and reimbursements
Recommendation for handling bills from the institution: make payments to the institution yourself and then request a reimbursement
After several years and two college students with one more to go starting next fall, I have found that it is easiest to pay all the bills from the school or school-affiliated entity by credit card or personal on-line check as soon as they come in and then withdraw the money from the 529 plan to reimburse yourself. While at first glance it seems to make more sense to request a check made and sent directly to the school that matches the bill, there a several reasons I recommend against direct payments:
Most 529 plans are not speedy about issuing checks and it is too easy to miss the due date and incur a late fee.
If the check is sent directly to the school you don't always know when and if it has been received.
Universities and colleges are not set-up well to receive hard-copy checks since everything is on-line these days and most 529 plans do not allow on-line payments (it can be daunting to even figure out how to send a check).
The amount you need to pay out of the 529 plan is often different than the amount on the bill from the school due to optional/non-qualified fees that might be included on the bill. Be sure to keep a copy of the original bill, showing deductions for non-qualified expenses, and the total amount that is qualified, in your student's 529 file in case the IRS has any questions. Set up a new file each year for all bills, receipts, a printout of your spreadsheet, and reimbursement documentation so that you can easily go back and find documentation if needed.
Recommendation for managing other expenses: keep it simple and consistent
For expenses your student incurs directly such as rent, utilities, meals, textbooks, computers, and other qualified expenses, I highly recommend that you have a simple system in place that results in monthly or regular reimbursements and receipts or other documentation for every expense.
After more than a year of trying to get my students to keep and give me paper or electronic receipts from meal expenses, we now use a simpler system. They each use a credit card for all 529 expenses and their ATM cards for all non-529 expenses and we use the credit card bills as documentation for those items for which they have no receipt. If they need to charge something to the credit card that is not a 529 expense, such as an airline ticket or airport shuttle, they let us know right away.
Each of my students tends to purchase their food at the same establishments, such as the nearby grocery store or coffee shop and the credit card bill shows the name of the establishment and city where purchases were made, so it's easy to track. In addition, at the grocery store, they know to put cosmetics and non-food-related items on a separate transaction using their ATM card. Rent and utilities are paid monthly electronically through checking accounts and we create receipts for those transactions showing the date, amount, address and recipient.
Each month, I carefully review the bill, assign the 529 expenses to each student, and send my students the credit card bill to review and verify all qualified expenses. Once verified, I make a monthly reimbursement request for those expenses, along with any university-billed payments made. My rule: if there is no documentation, it doesn't get reimbursed. All receipts and documentation go into 529 files for each student for each calendar year.
Use Excel to help with accounting
Organizing all expenses in an Excel spreadsheet with a separate sheet for each student, and each quarter (semester). I find it easiest to organize each worksheet into three reimbursable expense categories of tuition and fees, room and board, and other qualified expenses. Under each of these categories, I list each expense by date of payment, description, type of expense, and amount. For the descriptions it is perfectly acceptable to simply describe school tuition and fees as "tuition and fees," and any food expense with the name of the institution. For type of expense under each category, I use the following:
Tuition and Fees - types of expenses are simply either "tuition" or "fees" or "tuition and fees" if lumped together on the bill.
Room and board - for any expense on a bill from the school or affiliated housing organization (if this shows up on the same bill as tuition and fees then I break them out into different sections on the spreadsheet), I list the expense as "room" or "board" or if they are lumped together on the bill, as "room and board." For off campus housing, I list expenses as "food," "rent," or "utilities." If it's simply an expense for coffee at Starbucks, it still gets listed as "food."
Other Qualified expenses - I list these expenses as "computer," "textbook," or "required course expense."
I track the total to date for each category and at the bottom of the spreadsheet I include a running grand total for all three categories, a separate line for each reimbursement request, including the check number from the 529 account, and the amount received (entered as a negative number), and, finally, a total amount yet to be reimbursed. At the end of each month, I add any expenses for the prior month incurred, list any amounts for tuition, fees, room & board, and request the amount to be reimbursed from my 529 institution.
While I find a monthly reimbursement schedule to be easiest, I will request reimbursements for payments of large bills (i.e., tuition, fees) at the time of payment or just before I plan to make it. Whatever system you choose, I highly recommend not waiting until December 15 to do all the accounting and reimbursements.
At the end of the year and fall semester/quarter the amount to be reimbursed at the bottom of the spreadsheet should equal zero. If your student lives off-campus, I recommend that you also include the published maximum amount of room and board for the school year and convert it to quarter/semester (depending on your school's system) and appropriate calendar year on the spreadsheet to ensure that you stay under this maximum amount for rent, utilities and meal expenses.
Calendar Confusion
One of the most challenging features of the 529 system is that the calendar year requirement for accounting does not match the school year. To simply this, I keep separate worksheets for each quarter/semester within each calendar year. Once my students finish school in December, I do a final review of accounting and request the final reimbursement before the end of the year.
If your student lives off campus and January rent is due in December, it is acceptable to request the reimbursement in December. However, if the rent is not due until January, do not request the reimbursement until January. Likewise, if tuition for the next semester or quarter is billed in December and due in December, then it is acceptable to request the 529 reimbursement in December. If the bill is issued in December but not due until January 5, then do not request reimbursement until January. This is another reason it helps to pay the school bills yourself and get reimbursed by the 529 account, rather than request a check directly to the school, which can take 7 to 10 days.
Communication
Your student will need to both understand what qualified expenses are and take an active role in providing you with bills in advance of their due dates and receipts and documentation. Having a consistent schedule such as a conversation about expenses each week or each month, will save you from pulling your hair out later. One suggestion is to have your student text you every time they purchase something that they think is a qualified expense or schedule a weekly call or monthly review session. They must get in the habit of keeping receipts or taking pictures of them and sending them, or whatever system you prefer, or you will literally pay the price. For my students, we do a monthly call and review of all expenses and they also let me know if there is a large charge at the time it occurs. The more involved they are, the better.
Final thoughts
Saving for college through a 529 Plan can save you a lot of money, but managing distributions and reimbursements is challenging, particularly if your student lives off campus. Understanding the rules and developing a written policy that your student understands, along with a clear, consistent, and simple system for documenting expenses, paying for qualified expenses, and requesting reimbursements will help you make the most of your investment. It will also ease your anxiety, and help you avoid costly mistakes. Finally, it is critical that your student understands the rules, policies and system you develop and that they cooperate fully. With penalties of 10% for unqualified withdrawals and wasted money if you don't reimburse yourself for qualified expenses, it is well worth the investment of time to develop an effective system to manage your 529 distributions.
