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. However, you may be subject to federal taxes and a penalty if you don’t follow 529 withdrawal rules.
In this guide on 529 plan withdrawal rules, you’ll learn:
- How to calculate qualified education expenses to ensure tax-free distributions
- When to time your withdrawals correctly
- How to coordinate withdrawals from multiple accounts
- Ways to avoid penalties on non-qualified withdrawals
- Tips for handling leftover funds after graduation
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
Be careful not to withdraw more from your 529 than your qualified education expenses. In this example, if the 529 plan account owner withdraws more than $4,000, the excess distribution will be considered non-qualified.
Excess withdrawals trigger taxes and a 10% penalty on the earnings portion. If you accidentally withdraw too much, consider rolling the excess into another 529 plan within 60 days or prepaying next year’s expenses.
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:
- Receiving a tax-free scholarship (penalty waived up to the scholarship amount)
- Using educational tax credits
- Attendance at a U.S. Military Service Academy
- Death or disability
- Returning excess distributions promptly
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.
You can withdraw funds in January for qualified expenses paid later in the same year, such as in August, or withdraw funds in December for expenses you’ve already paid earlier in the same calendar year. Just be sure withdrawals and expenses match within the calendar 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 you don’t pay until January, you risk not having enough qualified higher education expenses (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 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
If multiple family members have 529 accounts for your child, coordinate withdrawals carefully to avoid confusion and unintended tax consequences. Recent FAFSA changes mean grandparent-owned 529 withdrawals no longer affect financial aid eligibility (though CSS Profile impacts remain). Consider consolidating ownership to simplify distributions, but confirm first if your 529 plan permits ownership transfers.
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 a sibling’s 529 plan account. Both options comply with 529 rules for withdrawal.
529 Withdrawal Rules to Know
When you’re making a withdrawal, consider these factors as well:
- Always match withdrawals to the same tax year as qualified expenses to avoid taxes and penalties and understand what expenses qualify.
- Keep detailed receipts organized for IRS documentation.
- Maximize tax savings by first claiming federal credits like the American Opportunity Tax Credit.
- If unsure about how much you’ll spend, consider year-end “catch-up” distributions.
- Confirm your school’s policy if having 529 distributions sent directly to the college.
- Know qualified room and board limits for off-campus living.
- Consider ABLE account transfers for beneficiaries with qualifying disabilities.
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 tool to save for your children’s college education. However, you must follow its scrupulous rules to maintain your savings and tax 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?
If your child receives a scholarship, you can withdraw up to the scholarship amount from your 529 without the 10% penalty—but you’ll pay taxes on the earnings portion if the withdrawal is not used for qualified education expenses. To avoid tax and penalties, only withdraw amounts matching your remaining qualified expenses.
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 529 plan 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 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 expenses indirectly related to attending school, such as transportation or health insurance.
