529 accounts are highly effective tools for saving for education. Used correctly, they can help the saver avoid thousands of dollars in potential tax obligations. However, withdrawals from 529 accounts must be done correctly to avoid these taxes and even worse penalties. The simple rule is that the money must be directly linked to educational needs and cannot be used for other purposes.
Instructions
1. Determine education costs to be incurred. The costs that can be covered with 529 account proceeds generally include tuition, books, fees, and at least part of the room and board for full-time students. Also, in this process, it is critical to identify expenses that are not educational. Use of 529 account proceeds for non-educational expenses can result in a 10 percent penalty and taxes on the entire withdrawn amount.
2. Order a disbursement from the 529 account. The disbursement may go directly to a school but it this is not required. The only rule is that the money be used for an eligible education cost. However, simplicity and transparency in case of an audit may make direct transfers to the school desirable. The disbursement can be ordered by simply contacting the financial institution that holds the 529 account and telling it where and distribute the funds.
3. Retain records for the Internal Revenue Service (IRS). In the unlikely event of an audit, it is critical to have financial records that link the disbursement from the 529 account to education costs. Therefore, bills for tuition and other things should be filed away with the records of the disbursement. While not technically a rule, it is often easier to time the payments from the 529 as closely to the bills' payment as possible to show a clear link to the IRS.
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