Qualified distributions from 529 college savings plans are limited to certain college costs. Once those limits are reached, any additional distributions are considered non-qualified. However, there is a simple method of increasing the amount of qualified distributions from a 529 plan.
This is important, because the earnings portion of a non-qualified distribution is subject to ordinary income taxes, plus a 10% tax penalty, while qualified withdrawals are entirely tax-free.
Limitation of qualified distributions based on college costs
The Internal Revenue Code of 1986 limits qualified distributions from 529 plans to certain college costs. These college costs include:
- Tuition, fees, books, supplies and equipment required for enrollment at a college or university that is eligible for Title IV federal student aid
- The purchase of a computer and peripheral equipment, computer software and internet access, even if not required by the college
- Room and board, if the student is enrolled on at least a half-time basis
- Special needs services for a special needs student
How to increase the limits on qualified distributions
You may know that you can appeal for more financial aid if special circumstances affect your ability to pay. But, did you know that you can also appeal to have the college financial aid office increase the cost of attendance?
Most often the financial aid office will be willing to make adjustments to the allowances for textbooks, transportation, dependent care, cost of a computer and software/internet service. Although transportation and childcare are not considered qualified higher education expenses by the Internal Revenue Code, the other costs are.
This will let you show the financial aid office that the total spent on required textbooks, supplies and equipment, for example, exceeds the allowance for textbooks, supplies and equipment in the college’s cost of attendance.
If your appeal is approved, you may then be able to take a larger qualified distribution from your 529 plan or qualify for a larger American Opportunity Tax Credit.
The Internal Revenue Code also allows for an adjustment to the cost of room and board if the student is living in housing that is owned and operated by the college and the actual cost of the housing exceeds the amount in the allowance in the college’s official student budget.
Even if the student is living off campus, the college might adjust the allowance for room and board to match the student’s actual costs. Most colleges base their allowances on old apartment rent surveys and will modify the allowance if students argue that the allowances are unreasonable and out-of-date. However, college financial aid offices will not increase the allowances to cover the cost of a luxury apartment. The financial aid office will also hesitate to increase the allowance beyond the cost of institutionally-owned and operated housing.