Don’t make these 3 mistakes when using your 529 to avoid IRS penalties

Callum Bedos
February 2, 2024
3 min read

The 529 plan is a popular and effective tool for saving for education. However, to fully benefit from its advantages and avoid penalties, it's crucial to use it correctly. In this article, we explore three common mistakes to avoid when utilizing your 529 plan.

Mistake 1: Misunderstanding Qualified Expenses

  • Overview: A common error is not understanding what counts as a qualified educational expense. Qualified expenses typically include tuition, books, supplies, and certain room and board costs, but there are nuances.
  • Avoidance Tip: Always refer to the latest IRS guidelines or consult with a financial advisor to ensure that your expenses are qualified. Documentation is key, so keep detailed records of all expenses paid with 529 funds.

Mistake 2: Getting your years mixed up

  • Overview: Withdrawals from your 529 must be used on qualified expenses made in the same year as the withdrawal. For example, if you withdrew $100 from your 529 on December 31st, 2022 and bought a $100 textbook on January 1st, 2023, this would make the expense ineligible!
  • Avoidance Tip: Plan carefully and consider the beneficiary's educational goals. If there are excess funds, explore options like changing the beneficiary to another family member who can use the money for their education.

Mistake 3: Not Coordinating with Other Educational Benefits

  • Overview: Failing to coordinate 529 withdrawals with other educational tax benefits, like the American Opportunity Tax Credit or the Lifetime Learning Credit, can lead to missed opportunities or penalties.
  • Avoidance Tip: Carefully time your 529 withdrawals and understand how they interact with other educational benefits. Sometimes, it's beneficial to use 529 funds for certain expenses and other benefits for different costs.

The best way to avoid back taxes and penalties, in our humble opinion, is through Backpack’s 529 Purchase Protection service. We can help certify the eligibility of your expenses, store and document your receipts and invoices, provide support through an IRS audit and even cover taxes and penalties if the IRS disagrees with our classification of “eligible”. To us, the biggest mistake would be not having 529 Purchase Protection!

Learn more and sign up for 529 Purchase Protection on our website.

Disclaimer:This article is for informational purposes only and does not constitute legal or financial advice. For specific advice regarding your situation, please consult a professional advisor.

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