529 Plan Withdrawal Rules

·5 min read
529 Plan Withdrawal Rules
529 Plan Withdrawal Rules

A 529 college savings plan, also known as a qualified tuition plan (QTP), is one of the best choices for meeting student educational expenses. Two of the 529 plan’s best features are tax-deferred growth of your contributions and later, tax-free withdrawals. But there are rules to follow if you set up a 529 college plan. If you don’t follow the rules then the IRS will get involved, which is something you want to avoid. You can also consider working with a financial advisor as you prepare financing for your children’s higher education.

529 Plan Rules: Qualified Education Expenses

According to the IRS, qualified education expenses are amounts paid for tuition, fees and other related expenses for an eligible student and beneficiary of a 529 college plan that are required for enrollment or attendance at an eligible educational institution.

Under 529 plan withdrawal rules, the following are considered qualified education expenses:

  • Enrollment fees: Includes student activity fees you are required to pay to enroll or attend the school. For example, an activity fee that all students are required to pay to fund all on-campus student organizations and activities.

  • Tuition and associated expenses: Tuition, books, fees, equipment and supplies

  • Room and board: This is allowable as a qualified expense only if the designated beneficiary of the 529 plan is a student enrolled at least half-time at an accredited and qualified educational institution. The expense for room and board can’t be greater than one of the following two amounts:

    • The allowance for room and board, as determined by the school, and included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student

    • The actual amount charged if the student is residing in housing owned or operated by the school

  • Special needs expenses: The student must be a special needs beneficiary and these expenses must be coordinated with the qualified and accredited educational institution.

  • Computers, software and internet access: Includes computer peripheral equipment, educational software and internet access and associated costs if the internet is used primarily by the beneficiary. Internet access is qualified if it will be used by the beneficiary during any of the years of education. Software is not qualified unless it is for educational purposes.

  • Qualified education loan payments: No more than $10,000 paid as principal or interest on qualified student loans of the designated beneficiary or the designated beneficiary’s sibling. A sibling includes a brother, sister, stepbrother or stepsister. For
    purposes of the $10,000 limitation, amounts treated as a qualified higher education expense for the loans of a sibling are taken into account for the sibling and not for the designated beneficiary. You can’t deduct as interest on a student loan any amount paid from distribution of earnings from a QTP after 2018 to the extent the earnings are treated as tax-free because they were used to pay student loan interest.

  • Apprenticeship Programs: Fees, books, supplies and equipment for participation in a registered and certified apprenticeship programs.

  • K-12 tuition: Tuition and fees incurred by a designated beneficiary, in connection with enrollment or attendance at an eligible elementary or secondary school. The limit is $10,000 per calendar year.

Expenses that don’t fall under the definition of “qualified” include:

  • Transportation and travel expenses: Includes gas, parking, mileage and airfare.

  • College testing and entrance exam fees: Includes college admissions application fees, standardized testing fees for ACT/SAT exams, fees for the CLEP and any other testing fees.

  • Health insurance premiums: Includes health insurance provided by the school.

  • Personal living expenses: This does not include room and board.

  • Fees for sports or club activities: Sororities and fraternities are part of this.

Tax Penalties to Avoid

529 Plan Withdrawal Rules
529 Plan Withdrawal Rules

There are some tax issues you should be aware of when it comes to 529 plan withdrawals as well. These include deductibility and credits, as well as penalties. Here are the tax penalties that will result if you don’t carefully follow 529 plan withdrawal rules:

  • When a distribution is made for qualified education expenses, both it and the earnings aren’t subject to taxes. If you take a distribution that is not for qualified education expenses, you could be subject to federal and state taxes on the earnings portion of that distribution at your ordinary income tax rate plus a 10% penalty.

  • The distribution is not subject to federal or state taxes. However, the earnings, capital gains and dividends are subject to federal and state taxes.

  • If the account is a custodial account, withdrawals can only be to the beneficiary. Otherwise, there will be tax implications.

  • Withdrawal earnings will be subject to taxes if they exceed adjusted qualified education expenses.

Bottom Line

First, calculate the cost of college or university. Then consider that 529 plans are one of the best ways to fund a college education. Be aware that 529 plan withdrawal rules are numerous and can be confusing. You can inadvertently trigger a tax penalty unless you make sure there’s record of your adjusted qualified education expenses. Keep good records and follow the withdrawal rules when distributing money from a 529 plan.

Tips on Saving for Education

529 Plan Withdrawal Rules
529 Plan Withdrawal Rules
  • If you’re saving money for a college education, you may want the assistance of a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Calculate payments on student loan debt and amortize your loan using SmartAsset’s student loan calculator. You can use these projections to inform your future financial plan.

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