Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / How 529 Plans Cover Your Child's First Car
Transcript
- Lucas: So, Luna, here's a question we get a lot from parents: can I use my 529 plan to buy my kid a car for college? Luna: That's a big one. I mean, a car is practically a necessity on some campuses, especially if they're off campus or commuting. Lucas: Right, but the short answer is: no, not as a qualified expense. The IRS is pretty strict about what counts. Tuition, fees, room and board, books, supplies, equipment, and now student loans, but a car? That's not on the list. Luna: So if you take money out of a 529 to buy a car, you're looking at a 10 percent penalty on the earnings, plus income tax, right? Lucas: Exactly. The earnings portion would be subject to ordinary income tax, plus that extra 10 percent penalty. And the penalty applies to the earnings, not the contributions. So if you've had the account for a while and it's grown, the penalty can be significant. Luna: But what about the argument that a car is needed for school? Like, they have to get to classes or a job. Lucas: The IRS doesn't really care about the necessity. They have a specific definition of qualified expenses, and transportation isn't in there. Unless it's part of a study abroad program where travel is required, but even then, it's the program fees that are covered, not the car itself. Luna: So what about a moped or a bike? Some campuses are bike-friendly, and you could argue it's equipment. Lucas: It's a stretch. Generally, the IRS hasn't clarified that bikes or mopeds count. The safest interpretation is that equipment means things like laptops, calculators, lab supplies. A bike might be considered personal use, not educational. Luna: Gotcha. So the car is a no-go straight from the 529. But there are workarounds, right? Lucas: There are a few. One is just to use other savings, like a taxable account or even a regular savings account. You might lose a little in tax efficiency, but you avoid the penalty and keep the 529 intact for what it's meant for. Luna: And what about the Roth IRA conversion? That's been a hot topic since Secure Act 2.0. Lucas: Right, so if the 529 has been open for at least 15 years, you can roll over up to 35 thousand dollars into a Roth IRA in the beneficiary's name. That's a great way to repurpose excess funds, but it's not a quick fix for a car purchase. You'd still need to pay taxes on the conversion, and it counts against the annual contribution limit. Luna: So it's more of a long-term strategy, not a way to get cash for a car now. Lucas: Exactly. Another angle is to use the 529 for qualified expenses and then free up other money for the car. For instance, if your kid's living on campus, the meal plan and room are qualified. So you pay those with the 529, and then the money you would have spent on room and board goes toward the car. Luna: That's a clever way to think about it. Sort of like budgeting across buckets. Lucas: It's a bit of mental accounting, but it works. The key is to make sure you're not taking distributions from the 529 for non-qualified expenses. As long as the distributions equal the qualified expenses, you're fine. Luna: What about state-level perks? Some states might offer deductions or credits that could offset the penalty if you withdraw for a car. Lucas: That's a good point. Some states have more generous rules, but in general, the federal penalty still applies. And if you took a state tax deduction on your contributions, you might have to recapture that deduction if you use the money for non-qualified expenses. So it's a double whammy. Luna: Ouch. So you really want to avoid that unless it's an emergency. Lucas: Right. And even then, there might be better options, like taking a loan or using a credit card if you have a low rate. But the 529 is meant to be a long-term savings vehicle for education. Luna: Let's talk about the timing. If you're planning to buy a car before your kid heads to campus, is there a way to structure it so the 529 doesn't get touched? Lucas: Absolutely. You can start a separate savings account specifically for the car. That way, you're not tempted to dip into the 529. You could even automate contributions. Some parents start a few years early, putting aside a bit each month. Luna: And if you're already saving for college, you might have to prioritize. A car is a want, but college is a need. Lucas: Exactly. And it's worth reminding folks that the 529 has a lot of flexibility now. You can use it for K-12 tuition, apprenticeships, even student loan repayments. But a car just isn't in the cards. Luna: So to recap, you can't use a 529 to buy a car without penalties, but you can plan around it by using other funds or by allocating your budget smartly. Lucas: Right. And before we wrap up, I want to mention something that keeps our show going. A small group of listeners supports us monthly through buy me a coffee dot com slash fexingo. That's what allows us to keep producing these deep dives without ads. Luna: Yeah, it really makes a difference. Even a small contribution helps us cover the research and production costs. Lucas: So if you find value in what we do, consider joining them. It's not about perks or anything, just supporting independent content. And now, back to the topic. Lucas: One more angle to consider: if your child is going to a school in a city with good public transit, maybe they don't need a car at all. That could save you thousands in the long run. Luna: True, but for many campuses, a car is essential. And that's where the planning comes in. Lucas: Let's talk about the financial aid angle. If you have a car in your child's name, it might be counted as an asset on the FAFSA, which could reduce their aid package. So it's important to think about ownership. Luna: So maybe keep the car in your name instead? Lucas: That could help. But there are also insurance considerations, and if the car is in your name, your insurance rates might go up. It's a trade-off. Luna: What about using a 529 to pay for car insurance? That seems like it could be a gray area. Lucas: Again, not qualified. Insurance is a personal expense, not an educational one. You'd have the same tax and penalty issues. Luna: So what's your final advice for a parent who's determined to buy a car for their college student? Lucas: Start a dedicated car fund early. Even if you can't contribute a lot, setting aside a little each month can add up. And keep the 529 focused on education. That way, you're not forced to make a choice between penalties and convenience. Luna: That's solid advice. And it's a good reminder that 529s are powerful but have their limits. Lucas: Absolutely. As always, it's about being intentional with your savings and knowing the rules.