I know there are 3 types of withdrawals from a 529 plan:
1 - Qualified Withdrawal -> Used for Tuition+Fees+Books+Room+Board (tax free)
2 - Taxable Withdrwawal -> Used for anything, up to the value of any scholarship received. (tax on gains)
3 - Non-Qualified Withdrawal -> Used for anything (tax + 10% penalty on gains)
Sometimes at the time of withdrawal, you are still not sure if the money will be qualified or not.
For example, you don’t know how much tuition for the fall semester will be in the beginning of the year. Lets say you make what you think is going to be a Taxable withdrawal in the beginning of the year, but it turns out that a portion of it gets used to pay for the unexpected increase in tuition. That would make money you thought was Taxable become a tax free withdrawal.
When you withdraw, they provide a checkbox with the following question:
“This withdrawal is not being used for qualified higher education expenses. This information is being collected on behalf of the Plan and will not affect how your withdrawal will be reported to the Internal Revenue Service.”
So lets say I check this checkbox because I intend to use is as a taxable withdrawal, but eventually I use some of the withdrawal for Qualified expenses, am I able to properly apportion that when doing the tax return? Or will I be forced to claim the entire withdrawal as taxable, despite using some of it for qualified expenses?
I don’t see why you have to withdraw before you get the bill and know if there is an increase in tuition. My bill comes 30 days before it is due, which is plenty of time to calculate what I can or need to withdraw, get the distribution, and pay on time. Tuition may increase for the fall term, but it should all stay the same for the rest of the school year.
I would mark it qualified unless you know for sure it will not be. If the IRS sees it is marked not qualified, it is more likely to generate a demand letter. If it is marked qualified and you later determine it is not, it is easier to report that than the other way round. You are just asking for an IRS notice if you call it not qualified then don’t report it on your taxes. They will have that form in their records saying it was a non qualified withdrawal.
Also, remember that a qualified expense for 529 is much more broad than for Education tax credits. For instance, room and board is a qualified education expense for 529.
You say you put away more money than you needed but if you don’t need it for living expenses, why not leave it there? If can be used for another child or for grad school or to get your child a new computer, which is a qualified expense. Of course, if you need it for living, that’s different.