Qualifying Criteria for 529 College Savings Plans

Section 529 plans seem to be wrapped in qualifications. Your plan must qualify and so must your student, but don’t allow these endless lists of criteria discourage you from using 529 plans. In order for a Section 529 plan to qualify under the IRS’s rules, it must meet the following criteria:

  • Contributions may be made only in cash, including checks, money orders, or payroll deductions, but not in stocks, bonds, or real estate.

  • After a contribution is made into a specific plan, you may not direct the investments. You may, however, change plans once each year.

  • You may not pledge the value of the account as security against any sort of loan.

  • The plan or program in which you invest must provide each designated beneficiary a separate accounting.

  • You can’t contribute more into an account, or group of accounts, for the benefit of a single designated beneficiary than the beneficiary will use in the payment of qualified higher education expenses. You have to try to estimate this amount.

When you make a contribution to a Section 529 plan, you’re not allowed any federal income tax deduction for the amount of your contribution. Depending on what state you live in, you may get a current state income tax deduction for part or all of your contribution each year.

After your money is safely tied up in a Section 529 plan, interest that you earn on it isn’t taxed until distributions are made to your designated beneficiary. And, if you use distributions from these plans to pay the qualified education expenses of a student at an eligible educational institution, accrued earnings generally aren’t taxed at all.

At this point, you may be thinking that the only educational institutions that these plans are qualified to pay for are colleges and universities. Not true. Qualified institutions include all postsecondary schools that are eligible to participate in U.S. Department of Education financial aid programs, including many vocational and technical schools, community colleges, and even some apprenticeship programs. Eligible institutions don’t need to be located in the United States; many foreign colleges and universities qualify. Check with the institutions you or your student are interested in to be sure that they qualify.

Strangely enough, the things you think of when the phrase “qualified student” comes to mind (grades, commitment, drive, and so on) have absolutely nothing to do with the IRS’s definition. For the purpose of Section 529 plans, a qualified student must meet the following criteria:

  • He or she needs to be the original designated beneficiary of the plan or, in the case of a tax-free plan rollover to another beneficiary, must be a member of the same family as the original beneficiary in one of these listed relationships:

    • Spouse

    • Child, grandchild, or great-grandchild (a lineal descendent)

    • Stepchild, stepmother, or stepfather (but no stepgrandchildren)

    • Brother, sister, stepbrother, or stepsister

    • Father, mother, or grandparents (a lineal ancestor)

    • Niece or nephew

    • Brother or sister of your mother or father

    • First cousin

    • An in-law, either mother, father, sister, brother, son, or daughter

    • Husband or wife of any person on this list

  • He or she must actually be an enrolled student at a qualified educational institution.

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