529 Plan Frequently Asked Questions

How are Section 529 Plan Distributions Reported?

When assets in a 529 plan are distributed, the financial institution holding the 529 plan will issue Form 1099-Q.

Besides the IRS, the financial institution issues the 1099-Q to the plan beneficiary if the distribution from a 529 plan is made directly to the 529 plan beneficiary or to an educational institution for the benefit of the beneficiary of that 529 plan.

If the withdrawal was not made for the benefit of the beneficiary, the financial institution holding the 529 plan sends the 1099-Q to the 529 plan account owner and checks Box 6.

Form 1099-Qs are not issued solely because of a change in beneficiary of a 529 plan college saving account as long as the new beneficiary is a member of the former beneficiary's family.

The Form 1099-Q breaks out the distribution of a 529 plan between basis and earnings. This is needed if the 529 plan distribution is not used for education and the recipient needs to determine the taxable portion of the distribution. The earnings within a 529 plan are not subject to backup withholding.

How do 529 Plans and Coverdell Education Savings Accounts Compare?

529 Plans and Coverdell Education Savings Accounts (ESAs), are similar in that:

• contributions to both 529 plans and ESAs are gifts,
• the assets in both 529 plans and ESAs grow tax-deferred and
• distributions from both 529 plans and ESAs are federal income tax-free until 2011 if they are used for qualified educational expenses. They may be subject to state income tax.

However, there are differences between 529 plans and Coverdell Education Savings Accounts.

• Coverdell Education Savings Accounts or ESA contributions are limited to $2,000 per beneficiary per year. 529 plan contributions are not limited, though most contributors will want to contribute $12,000 or less to escape gift tax filing.
• In addition, 529 plans are subject to a "maximum contribution amount" which when reached, prohibits any new contributions from being made on behalf of that beneficiary under that state's plan. The maximum contribution amount is based on the total market value of an account and not just on the contributions made to the account. Most 529 plans have adopted formulas under which this maximum is recalculated every year.
• You can control the investments in an ESA. In a 529 plan you are locked into a limited number of investment vehicles.
• Contributions to an ESA for one year can be made by April 15 of the following year. Contributions to a 529 plan may be made at any time until the maximum contribution limit of the 529 plan is reached. However, for gift tax purposes, contributions to 529 plans for a year must be made by December 31.
• Qualified distributions from an ESA can be used for kindergarten expenses and above. Qualifed 529 plan distributions only apply to college and above.