529 Plan Mismatches

How to Avoid Major Tax Issues

529 Plan Mismatches
November 16, 2016

529 plans are one of the best options available to save for your child's college education. Named after a section of the tax code, 529 plans are state-operated savings plans that provide tax benefits as long as the money is used for qualified educational purposes.

State 529 plans operate in a similar fashion to 401(k) plans or IRAs in that your money is invested in the market through options you choose within the plan. Earnings grow free of taxes, and as long as the money is used to pay for educational expenses, the earnings are not taxed upon withdrawal. Because of this benefit, you have to be careful with the mechanics of withdrawal towards the end of the calendar year.

The mismatch of calendar years for tax purposes is a common mistake made by first-time users of the 529 plans. People are increasingly accustomed to automated financial systems, and 529 plans take some time and thought to execute properly. Colleges do not have access to the account; you have to initiate the withdrawal request yourself and specify the amount that is being withdrawn to pay costs.

Since semesters or quarters generally end in December and begin in January, the timing of the bill payment is important. Be sure to withdraw the 529 funds in the year in which you will pay the bill. If you intend to pay the bill in December, withdraw your funds in December. If you are targeting a January payment, withdraw the funds in January.

Bad timing can throw off your 529 payments in one other respect — 529 withdrawals are not instantaneously available for payment. It could take up to two weeks for the funds to be processed, so if you have waited until the last few days to make a payment, the funds may not be available. Not only could this cause you to incur late fees and other problems on the college's end, it may also cause the year-end mismatch problem if this scenario occurs in December.

If the tuition bill is due early in January and the 529 payments may take too long, how do you avoid falling into the mismatch trap? If you have the available funds, the simplest way is to pay the college tuition yourself out-of-pocket in early January and then immediately request reimbursement from the 529 plan. You will be short on cash for a week or two until the withdrawal is processed, but you will avoid potential IRS hassles. Have documentation in hand to prove that the expenses are at least as much as your withdrawal.

Another option that may be available is to coordinate with your 529 plan to have the withdrawal paid directly to the school instead of routing it through your account. In that case, the college will make the withdrawal in the correct calendar year — but this is something you will have to set up with your 529 plan and the college. It does not happen automatically.

Not sure about your options? Check with your 529 plan administrator and the college. It is in both of their best interests to have the transaction go as smoothly as possible, just the same as it is for you. A few minutes of clarification beforehand can save potential confusion and hours on the phone straightening out a disjointed payment situation — not to mention the agony of incorrectly filed taxes and a subsequent battle with the IRS. You know who is going to lose that battle.

Winnie Sun is a registered representative with, and securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Sun Group Wealth Partners, a registered investment advisor and a separate entity from LPL Financial.

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Erin | 11.20.15 @ 15:41
This is great information. These plans confuse me quite a bit, and this clears a big part of it up quite nicely.
Beverly | 11.20.15 @ 15:41
Some good tips to keep in mind.....if only we had done a 529 plan. Thankfully our boys are going/will go to a community college and that is A LOT cheaper and more affordable,
Daniel Dohlstrom | 11.20.15 @ 15:42
with the cost of education these days every possible option like this is needed. Great info on using it as needed
Steffanie | 11.20.15 @ 15:42
Really great information that we can definitely use. Will be keeping them in mind
Alec | 11.20.15 @ 15:43
This sounds frustrating. Good planning seems to be the best option in this case. I'd personally opt to let the college withdraw the money itself to avoid the hassle!
Amanda | 11.20.15 @ 15:43
I have a 11 year old son, and have been thinking about starting a 529 plan, thanks for this information as I didn't know about this. Sounds like having the college withdrawls the payments is the best way to go in paying, that way I'm not punished for any mishaps or late payments. Anyone else have this plan? Is it a good deal or worth it?
Elaine | 11.20.15 @ 15:43
This sounds like a great option however, the time difference I bet will be confusing to many. I hope people will listen to this articles advice and get clarification with the college/529 Advisor.
Carla Truett | 11.20.15 @ 15:45
Good to see there are great things happening for college students and their parents. Saving is hard in this day and time. We need all the help we can get.
Tina | 11.20.15 @ 15:46
I need to look into this further. With 5 kids and one income, this looks like a great idea for our family. Thanks for the info.
joann | 11.20.15 @ 15:47
These are plans that i personally don't need, but I do have grand children that my kids are saving for college for. I WILL DEFINITELY PASS THIS INFORMATION ON TO THEM BECAUSE I KNOW THEY WILL NEED TO UNDERSTAND THE INS AND OUTS OF THESE PLANS,
Britt | 11.20.15 @ 15:47
I always get all the different types of plans confused because there's so many. I'll have to keep this one in mind.
Nancy | 11.20.15 @ 15:50
I can see why mistakes are made. It sounds like a dance that has to be performed with exactly the right timing.
Nancy | 11.16.16 @ 00:19
I have had a lot of questions about 529 and this answered some of them. I never fully understood the timing issue. Until now. This sounds like a good option for affordable college.
Jane | 11.16.16 @ 01:21
It looks like it could be a nightmare to work out with the IRS if there is a 529 mismatch.
Christina | 11.16.16 @ 16:46
Good information! Wish I would have had this before my kids were already in college.
Daniel Dohlstrom | 11.16.16 @ 18:29
Fantastic stuff here! The costs of education are unreal these days so any and every cent you can save is needed
Zanna | 11.16.16 @ 22:17
I had no idea it could take up to two weeks for the plan's funds to be available. This will be helpful to know when we start to withdraw from the plan.
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