529 savings plan strategy for an adult with ongoing income
May 1, 2021 8:59 AM   Subscribe

I'm an adult returning to college. I have a part-time job that I intend to keep working while in school. Can I withdraw money from a 529 college savings plan to pay for living expenses even though I have income? US-centric question.

So I'm returning to college next month(!) for a career-change second bachelor's degree. I am paying for it myself. I have about 80% of the money I need saved, and the rest of the money will come from me earning ~$1000/month at a part-time job, which I already have.

I recently learned that I can open a 529 savings plan for myself, and it actually makes sense to do so. Not really from the investment POV - the money won't have much time to grow - but because in my state (Colorado), I don't have to pay income tax on whatever I invest in the 529. That's a 4.5% savings on about $55,000. This was all very surprising to me, because I thought 529s were only for children, so I'm still trying to wrap my head around what it all means and how it works.

Okay, so here's what I'm wondering about.

Let's say I earn $1000 in a month, and I have $1400 of eligible room-and-board expenses (house payment, utility bills, food). Tax-wise, what's most optimal is for the earned $1000 to go to tuition* or to non-529-eligible expenses, and for the $1400 for room-and-board to come from the 529.

Is that okay? Or would an auditor look at that and say that I was only eligible to take $400 from the 529 because I had earned $1000 that month? Is it still okay if the $1000 goes into a savings account for when tuition comes due, instead of being spent right away? What if the $1000 goes into the 529? I.e. is it allowed to both invest and withdraw in the same month?

I haven't found anything to say that this is not okay, but also almost everything I find about 529s is about dependent children. Many college students work, though, and I haven't found anything to say that that would cause any issue with being eligible to take money from the 529. I just want to be sure and not get myself in trouble! I am new to the world of strategically moving your money around...

*(because of the Lifetime Learning Tax Credit. The first up-to-$10k of every year's tuition and fees will be coming from savings or current income and NOT from the 529. My spouse is an independent contractor so this will yield major tax savings for us despite my low income.)
posted by mandanza to Work & Money (2 answers total) 2 users marked this as a favorite
Best answer: Whether you can spend 529 funds without incurring tax or penalty is based on what you spend it on, not what your income is. If you're spending it on living expenses, your idea of your necessary budget is probably different from (that is, higher than) the school's. You'll have to look at their financial aid info to find out what they allocate for off-campus students. That's your cap.

Your distributions must occur in the same tax year as the relevant expenses, so be careful with timing around the end of the year. I think some states do have a minimum "holding time," so you'll need to check Colorado's details, but I also think it tends not to be a particularly long period of time. As a practical matter, even if there's no minimum period, I'm currently doing a distribution for a relative, and based on how that's going, unless Colorado's plan is super-efficient, you're unlikely to be able to contribute and withdraw the exact same funds in the span of a month.

Please note that whatever expenses you use in calculating your Lifetime Learning Tax Credit must be deducted from your total eligible expenses. (It sounds like you're doing that already.)
posted by praemunire at 9:22 AM on May 1, 2021

Response by poster: Thanks, praemunire! Just what I needed to know. Very good to know about the year-end considerations, too!
posted by mandanza at 8:49 AM on May 2, 2021

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