The South Carolina Future Scholar 529 plan is an excellent way for parents to save for college, but there are some important rules to understand in order to ensure that you make only “qualifying “ distributions, so that you don’t have a surprise tax liability.
First and most importantly, make sure that you time distributions to coincide with expenses paid. The regulations are such that money not spent within a calendar year that it is withdrawn may be subject to taxes and penalties.
For example, say Pete Sr. receives Pete Jr.’s college bill in late November of 2013 for $10,000 for the Spring semester that starts January 15th, 2014. He decides to pay the bill in December, but with the hectic holiday schedule he forgets to withdraw the 529 funds in 2013. Instead, he requests the 529 distribution in 2014. His expenses don’t match the withdrawals for 2013 or for 2014. He will not be able to claim the distribution for the 2013 as it was disbursed in 2014 and the 2014 distributions will also not be qualified, as the expenses were paid in 2013. So if $10,000 was disbursed in 2014 and $3,000 of that was earnings*, the $3,000 would be taxable and a 10% penalty would be assessed.
Reimbursement Are Qualified
Second, you want to make sure that the expenses you are seeking reimbursement for are qualified and are net of any scholarships or other tax credits. Qualified expenses include tuition, books, and mandatory fees and supplies in conjunction with enrollment in all eligible institution. The student must also attend school at least halftime.
Say Mary Alice attends USC full time and her tuition, books, room and board are $10,000 a year for one semester. She also, however, receives $2,000 of scholarships a semester. Her parents should only withdraw $8,000, not $10,000.
Rent Is Consistent
Note: Rent for off-campus apartments is qualified as long as the rent is consistent with on campus housing. If a student prefers cooking in her apartment instead of the cafeteria, she can get reimbursed for meals as long as the expenses are in line with the school’s cafeteria plan charges. She will also want to keep receipts for any food and dining expenditures in case of an audit.
Any taxable distributions are subject to a 10% penalty, but there are exceptions. The 10% penalty will not be assessed if the distribution is due to a death or disability. A more common exception is that no penalty is assessed on any tax-free scholarships or fellowships. So, although the earnings portion of any distribution will be taxed, the penalty will be waived for an amount equivalent to scholarships or grants received by the student.
So from the example with Mary Alice above, she will pay taxes on the $2,000 of earnings if her parents withdraw the full $10,000, but no penalty will be incurred.
*you don’t pay taxes or penalties on contributions, as they were already taxed. 529 contributions are made with post tax dollars.Read Full Article