You can withdraw 529 plan savings tax-free to pay for qualified education expenses, which include costs required for enrollment and attendance at in-state, out-of-state, public and private colleges, universities, or other eligible post-secondary educational institutions. Qualified 529 plan expenses include up to $10,000 per year in K-12 tuition expenses. But you may be subject to federal taxes and a penalty if you don’t follow important 529 plan withdrawal rules.
It’s up to the 529 plan account owner to calculate the amount of the tax-free distribution and how they want to receive the funds. If you’re wondering how to withdraw from 529 to pay school tuition, you can usually request a withdrawal on the 529 plan’s website by telephone or mail.
Here are four steps to help you understand 529 withdrawal rules, navigate the 529 plan withdrawal process, and avoid paying taxes and penalties on your savings.
Step 1: Calculate Your Qualified Education Expenses
529 plan account owners can withdraw any amount from their 529 plan, but only qualified distributions will be tax-free. The earnings portion of any non-qualified distributions must be reported on the account owner’s or the beneficiary’s federal income tax return. Plus, those withdrawals are subject to income tax and a 10% penalty. Of course, you might consider exploring exceptions to the penalty to avoid the extra costs.
To calculate a 529 plan beneficiary’s qualified education expenses, first, add up:
- College expenses, including tuition, fees, books, supplies and equipment, computers, and room and board if the student is enrolled on at least a half-time basis
- K-12 tuition and fees (up to $10,000 per year)
Next, subtract any tax-free educational assistance, including:
- Tax-free scholarships
- Educational assistance through a qualifying employer program
- Veteran’s educational assistance
Next, subtract the amount of any expenses used to justify the American Opportunity Tax Credit (AOTC) or Lifetime Learning Tax Credit (LLTC).
For example, consider a beneficiary who:
- claims the maximum $2,500 AOTC,
- has $10,000 in qualified expenses, and
- won a $2,000 tax-free scholarship.
This person may withdraw $4,000 tax-free from a 529 plan:
$10,000 (qualified expenses)
– $4,000 (used to generate AOTC)
– $2,000 (scholarship)
= $4,000 tax-free 529 plan distribution
In this example, if the 529 plan account owner withdraws more than $4,000, the excess distribution will be considered non-qualified. The earnings portion of the non-qualified distribution is taxable; however, the 10% penalty may be waived on a non-qualified distribution up to $2,000 (the amount of the beneficiary’s scholarship). Other exceptions to the 10% penalty include:
- Tax-free educational assistance
- Receipt of education tax credits
- Attendance at a U.S. Military Service Academy
- Death or disability
- Return of excess distributions
Step 2: Determine When to Withdraw
You should take 529 plan distributions during the same year you paid for the qualified expenses. For example, do not include second-semester tuition expenses that you paid for in December of the previous year.
It doesn’t matter if you withdraw funds in January for expenses not paid until August. Or if the withdrawal occurs in December for expenses previously paid during that year. Make sure they match up within the same calendar year, not the academic year.
If you withdraw the 529 money in December for a tuition bill that isn’t paid until January, you risk not having enough QHEE during the year of the 529 withdrawal. Likewise, if you take a distribution in January to pay for expenses from the previous December, that distribution will be non-qualified.
Towards year-end, 529 account owners should determine exactly how much was spent on qualified expenses during the year and make the appropriate “catch-up” distribution from the 529 plan. As part of this process, determine if the AOTC is maximized by paying second-semester college bills in December versus January.
Step 3: Decide Which 529 Plan Account to Withdraw From
Before the 2023 FAFSA for the 2024-2025 school year, funds withdrawn from a grandparent-owned 529 plan counted as student income on the Free Application for Federal Student Aid (FAFSA) and may have hurt the student’s eligibility for need-based financial aid.
However, the new, simplified FAFSA form will eliminate the grandparent financial aid trap. The updated FAFSA will not require students to report cash reports, including grandparents’ money. So, any distributions that a grandparent takes from a 529 plan in 2022 or later (due to prior-prior reporting) will not be included in the student’s financial aid calculations on the FAFSA. Note, however, that grandparent support is still considered on the CSS Profile form.
Additionally, some parents have multiple 529 accounts for a few reasons. Most often,a parent may prefer an out-of-state 529 plan over the in-state 529 plan but does not want to forsake the state tax deduction in states offering that particular benefit. Contributions are first made to the in-state 529 plan to take maximum advantage of the state tax benefit, and any remaining money is contributed to the out-of-state 529 plan. Moreover, parents might have separate 529 plans for separate children.
Different accounts will experience different growth rates. Tapping into the account with the higher earnings ratio once your child gets to college locks in maximum tax savings. If your child graduates when you still have money in 529 plans, you’ll minimize the non-qualified distribution tax costs because the lowest-growth account is left for last.
Step 4: Complete a Withdrawal Request
Parents can make 529 withdrawals by completing a withdrawal request form online. Some plans also allow 529 plan account owners to download a withdrawal request form to be mailed in or make a withdrawal request by telephone.
The withdrawal request form will typically ask for information such as:
- 529 plan account number
- Your name and social security number or Taxpayer Identification Number
- The beneficiary’s name and social security number or Taxpayer Identification Number
- Phone number
If the 529 plan account owner is taking a partial withdrawal, they can select a portfolio or portfolios to withdraw from. The total dollar amount entered from each portfolio should equal the total distribution amount.
If possible, avoid making the distribution payable to the account owner. When 529 plan distributions are payable to the beneficiary, the beneficiary’s college, or K-12 school, a Form 1099-Q will be issued to the beneficiary. Non-qualified distributions payable to a parent may result in a higher tax liability.
You can also roll 529 plan funds into another account with the same beneficiary or into a sibling’s 529 plan account. Both options comply with 529 rules for withdrawal.
529 Withdrawal Rules to Know
When withdrawing from your 529 plan, it’s usually a good idea to lock in your tax benefit by taking the maximum amount from your accounts that will qualify for tax-free treatment. Even if you’d prefer to withdraw less than the maximum amount this year to spread the money over the college years, it may still be worth withdrawing the maximum. Then, you can follow this up by making new contributions to the 529. This way, you have a higher tax basis in the account and even additional state tax deductions.
Don’t wait until the last minute to calculate your 529 withdrawals for the year. You must give your 529 plan administrator sufficient lead time to process the distribution request in the current calendar year.
529 distribution rules forbid “double dipping” by using your 529 withdrawals to cover expenses you’ve used tax incentives to pay for, such as the American Opportunity Tax Credit and the Lifetime Learning Credit. So, remember this as part of your 529 planning if you plan to access these tax credits.
Requesting payment directly to your college can be a simpler way to handle your 529 distributions, but always check the school’s policy around funds received directly from a 529 plan first. They should treat the 529 plan money as a college bill payment.
However, colleges often receive checks for outside scholarships their students won, and they typically reduce the students’ federal, state, and institutional need-based grants by an equivalent amount. You would not want the college to view the 529 money like it views a scholarship and reduces your child’s financial aid package.In this case, you should request the distribution be made payable to you or your child and then use it to pay the college.
Under IRS 529 withdrawal rules, qualified room and board expenses for students living off campus can’t exceed the university’s official cost of attendance. You can usually find this info on your school’s website.
Students diagnosed with a significant disability before age 26 can also transfer funds to an ABLE account without incurring a penalty. This is another type of tax-advantaged savings account only available to disabled individuals.
Remember that even if you don’t use all your 529 funds to pay for college, there are plenty of other ways to spend unused 529 plan money without paying tax, such as changing the beneficiary on the account, making student loan repayments, or rolling over funds to a Roth IRA.
Tips for Withdrawing Funds From Your 529 Plan Tax-Free
Now that we’ve covered the withdrawal rules let’s walk through a few quick tips to help you streamline the process and maximize your benefits.
- Get up to speed: 529 accounts have more policies and rules than your average traditional savings account. Awareness is key — conduct research and consult your financial advisor to ensure you know exactly what you can pay for with your 529 account. You might even want to sit down with an advisor and accountant to calculate your qualified expenses.
- Keep receipts, always: Are loose receipt slips for textbooks, electronics, and other qualified expenses cluttering up your office? Even after you’ve submitted your reimbursem*nt form, it’s wise to hold onto them. Consider investing in a few file folders to keep yourself organized, but don’t throw them away.
- Match withdrawals to the year’s qualified expenses: The last thing you need is to withdraw funds for a qualified expense that becomes unqualified because you paid for it too late. Ensure withdrawals match up with the current year’s payments to avoid taxes.
Explore more tips for tax-free 529 withdrawals.
What Happens to Leftover Funds After Graduation?
You might have leftover funds in a 529 plan account after your beneficiary graduates from college or decides not to go to college. Under 529 plan withdrawal rules, the 529 account owner may:
- Use the money to make student loan payments
- Roll over to a Roth IRA (starting in 2024)
- Liquidate the account and pay income tax and a 10% penalty on the earnings
- Keep the funds in the account to use for graduate school or continuing education
- Change the beneficiary to a qualifying family member who will use the funds for college
- Save the funds for a future grandchild
The Bottom Line
Your 529 plan is an excellent asset to your children’s college education. However, you must follow its scrupulous rules to maintain your savings and tax-free benefits when you withdraw funds for school. That means knowing qualified and non-qualified expenses, options for leftover funds, and penalties.
Frequently Asked Questions (FAQs)
How do scholarships impact 529 plan withdrawals?
Scholarships are considered tax-free educational assistance, but it’s a myth that any scholarship impacts your 529 plan withdrawals. As long as your withdrawals are used to pay for qualified education expenses. If you use your scholarship to pay for your college expenses and try to take a non-qualified withdrawal, then you would incur a 10% penalty and be charged income tax for the amount of that withdrawal.
How much can I withdraw from my 529 plan each year?
If your child is in college, there is no limit for 529 withdrawals. The only requirement is for the withdrawals to be used for qualified expenses. If you’re paying for private school expenses for younger children, you can withdraw up to $10,000 tax-free for qualified education expenses for children between K-12.
Can you withdraw from your 529 plan at any time?
Yes, you can withdraw from your 529 plan at any time. However, ensure you use your withdrawals for that year’s qualified expenses. You also have to make sure that you withdraw your funds at the right time to align with when you’re going to be using the funds.
What happens if I use 529 plan withdrawals for non-qualified expenses?
If you use unused 529 plan withdrawals for non-qualified expenses, you’ll have to pay income tax and a 10% penalty.
What expenses are not eligible for tax-free withdrawals from the 529 plan?
Non-qualified expenses include college examination, application, testing fees, transportation, and ACT/SAT prep. You also can’t pay for related expenses directly in line with attending school. For example, you can’t use those funds for transportation, health insurance, or miscellaneous living expenses.
