Saving for college with a 529 plan is easy. Once you set up your account, you decide when you want to contribute and how much. Most plans even allow automatic deposits from your checking account. But things can get tricky once it’s time to take a 529 plan withdrawal to pay for college.
If you take a non-qualified withdrawal, you’ll miss out on tax benefits and may have to pay a penalty. These five tips will walk you through the withdrawal process and help you maximize the value of your college savings.
1. Calculate your qualified expenses
529 plans offer tax-free growth and tax-free withdrawals, but only when the funds are used to pay for qualified higher education expenses. For college students, this includes tuition, fees, books, supplies, room and board (if the student is enrolled at least half time), computers and internet access and expenses for special needs beneficiaries. It does not include costs of transportation or health insurance unlessthe college charges them as part of a comprehensive tuition fee, or the fee is identified as a fee that is “required for enrollment or attendance” at the college.Up to $10,000 per beneficiary can also be withdrawn tax-free to pay for tuition at elementary and secondary schools. Under the SECURE Act of 2019, 529 plans can be used to repay student loans and pay for registered apprenticeship programs.
After you add up your total qualified expenses, subtract any amount that was used to generate an American Opportunity tax credit (AOTC) or Lifetime Learning credit. These are federal tax incentives offered to families paying for college. With the AOTC, parents who qualify can claim a tax credit for 100% of the first $2,000 spent on college expenses for a dependent child, and up to 25% of the next $2,000, for a $2,500 total tax credit. However, you cannot include expenses used to support the credit in your 529 plan qualified expenses. The IRS does not allow taxpayers to double-dip tax benefits.
2. Decide which account to use
Your child may have more than one 529 plan account. Parents sometimes contribute to an in-state 529 plan just enough to claim a state tax deduction, and then deposit the rest of their savings into another plan. If this is the case, consider withdrawing from the account with the highest growth rate first. This can help minimize the tax implications if you end up taking a non-qualified 529 plan withdrawal in the future.
It’s also common for grandparents and other relatives to have accounts separate from the child’s parents. Be sure to discuss how much they will withdrawfrom each account before taking a distribution. If the total amount of the withdrawals exceeds the amount of the beneficiary’s qualified expenses, someone could wind up with a non-qualified 529 plan withdrawal.
3. Match your 529 plan withdrawal to qualified education expenses
You should take 529 plan distributions during the same calendar year that you pay for the qualified expenses. Many parents pay tuition with cash or a credit card, and then reimburse themselves with the student’s 529 plan. But if you withdraw the 529 plan funds first, before the tuition bill is due, pay attention to the calendar. For example, you must take the distribution and pay your tuition bill in 2023 for it to count as a 2023 expense.
4. Make the distribution payable to the beneficiary
You generally have the choice of making your distribution payable to the account owner, the beneficiary or the college. Directing the payment to the beneficiary and then using the money to pay the college is usually the simplest option. If the Form 1099Q has the beneficiary’s social security number, any non-qualified withdrawals are taxed at their lower tax bracket.
5. Evaluate any leftover funds
What if there is remaining money in the 529 plan account after you’ve paid for all of your child’s qualifying expenses? You have a couple of options. You can save the money for your child to attend graduate school or change the beneficiary to another family member.
If your child used any tax-free scholarships to pay for college, you can take a non-qualified withdrawal up to the amount of the award without incurring a penalty (you will still have to pay income tax on the earnings portion). Or, you can consider leaving the money in the account for a future grandchild.
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FAQs
If your withdrawals are equal to or less than your qualified higher education expenses (QHEEs), then your withdrawals including all your earnings are tax-free. If your withdrawals are higher than your QHEE, then taxes, and potentially a penalty, will be due on earnings that exceed your qualified expenses.
How do I avoid taxes on 529 withdrawals? ›
If your withdrawals are equal to or less than your qualified higher education expenses (QHEEs), then your withdrawals including all your earnings are tax-free. If your withdrawals are higher than your QHEE, then taxes, and potentially a penalty, will be due on earnings that exceed your qualified expenses.
What is the 529 loophole? ›
On the 2024-25 FAFSA, students are no longer required to report cash gifts from a grandparent or contributions from a grandparent-owned 529 savings plan. Because of this, grandparents can now use a 529 plan to fund a grandchild's education without impacting their financial aid eligibility.
Does IRS check 529 withdrawals? ›
The IRS Knows All
In any year you withdraw money from a 529 Plan, you will receive a tax document from the 529 Plan provider (Form 1099-Q). That means you cannot sneak one by on your tax filing. If some or all of the amounts withdrawn are taxable, you will have to report it on your 1040.
What documentation is needed for 529 withdrawal? ›
In each year you take withdrawals from a 529, the plan administrator should issue a Form 1099-Q, which reports the total distribution taken from the account in a given year, the portion of the distribution that came from earnings in the account, and the portion of the distribution that represents the original ...
Do I need to keep receipts for 529 withdrawals? ›
You should allow 7–10 business days for the check transfer. That's why, to ensure you leave enough time for the payments to arrive, it's best to not wait until the last minute to request your withdrawal. Also, a best practice is to keep receipts, if you're paying the bill with 529 proceeds.
How do I withdraw money from my 529 without penalty? ›
You can only get the common exceptions to the 10 percent penalty:
- The beneficiary of the plan has died or become disabled.
- The beneficiary received a tax-free scholarship.
- The beneficiary received educational assistance through a qualifying employer program.
- The beneficiary is attending a U.S. military academy.
529s are funded with after-tax dollars, which means that over time the investments grow tax-free. These plans are attractive for wealthy families because they provide a way for a parent or grandparent to transfer much more money to a child than they would be able to without incurring gift taxes, Stokes says.
Do grandparents get tax deduction for 529 contribution? ›
529 plans are one of the best ways for grandparents to save for college because while contributions to a 529 plan are not deductible at the federal level, over 30 states offer a tax deduction or credit for contributions.
Can I use my child's 529 for myself? ›
Your 529 can be used for student loan repayment up to a $10,000 lifetime limit per individual. Up to $10,000 annually can be used toward K-12 tuition (per student). You can transfer the funds to another eligible beneficiary, such as another child, a grandchild, yourself or a friend.
There are no time or age limits on using a state 529 college savings plan. Money can be kept in a 529 plan indefinitely. 529 plans can be used for graduate school, not just undergraduate school, and can be passed on to one's children.
Should 529 distributions go to parent or child? ›
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.
How do I withdraw money from my 529 to pay tuition? ›
You can disburse funds from your 529 in one of three ways:
- Send payment directly from the 529 to the school.
- Send payment to your home, deposit it into your account, and then send it to the school.
- Send payment to your home, deposit it into your child's account, and then have them send it to the school.
This means keeping detailed records that include account statements with tuition and room and board; receipts for computer equipment, accessories, software, and internet; syllabi documenting course requirements (e.g., lab fees); canceled checks and records showing withdrawals for all other qualified education expenses.
Is a car a qualified 529 expense? ›
Transportation costs, which are generally considered a nonqualified expense, may qualify depending on a student's special needs. "There really are a lot of ways to be creative with 529 plans," Mejia says.
Do you get a 1099 from 529 withdrawal? ›
You'll receive an IRS Form 1099-Q when you withdrawal money from a 529 plan or a Coverdell Education Savings Account (Coverdell ESA).
Can I convert my 529 to a Roth IRA? ›
As of January 1, 2024, owners of 529 plan accounts can make tax and penalty-free rollovers to Roth IRA retirement plan accounts, subject to certain limitations. This has been welcome news to many families who worried about having unused or leftover funds in a 529 plan account.
Can I roll a 529 into a Roth IRA? ›
A rollover can only be made to the Roth IRA of the 529 beneficiary—not the owner of the 529 account (if different). The 529 account must have been in existence for a minimum of 15 years before rolling funds to a Roth IRA.
How does 529 reduce taxable income? ›
1. 529 Plans Offer Unsurpassed Income Tax Breaks. Although a contribution to a 529 plan is not an income tax deduction, earnings in a 529 plan grow federal tax-free and are not taxed when you withdraw the money to pay for numerous college and other qualified education expenses.
