A Breakdown of NC 529 Withdrawal Rules

The NC 529 Plan helps families save for future educational costs with tax advantages. Money in an NC 529 account can grow free from federal and North Carolina state taxes, and withdrawals for approved expenses are also tax-free. Realizing these benefits depends on following the specific rules for withdrawals. Understanding the difference between qualified and non-qualified withdrawals is important for every account holder to maximize their savings.

Qualified Withdrawals for Educational Expenses

The main purpose of an NC 529 Plan is to pay for qualified education expenses without incurring taxes on the account’s earnings. These expenses are defined by the IRS and cover costs for education from kindergarten through post-secondary schooling and apprenticeships. Adhering to the rules ensures that withdrawals maintain their tax-advantaged status.

Qualified Higher Education Expenses

For post-secondary education, qualified higher education expenses (QHEE) include costs required for enrollment or attendance at an eligible institution. This covers tuition, mandatory fees, books, supplies, and equipment required for courses. These items must be mandated by the institution for enrollment or attendance.

The rules for room and board require the student to be enrolled at least half-time. The amount that can be withdrawn is limited to the greater of the allowance for room and board in the college’s cost of attendance, or the actual amount charged for on-campus housing. Expenses for computers, peripheral equipment, computer software, and internet access are also qualified if used primarily by the beneficiary for their studies.

K-12 Tuition

The scope of the NC 529 Plan extends to primary and secondary education. Account holders can withdraw up to $10,000 per beneficiary, per year, to pay for tuition at an eligible elementary or secondary public, private, or religious school. This provision allows families to use their tax-advantaged savings for educational needs before college. This $10,000 annual limit applies only to tuition and does not cover other K-12 school-related costs like fees, books, or uniforms.

Student Loan Repayment

NC 529 funds can also be used to address educational debt after schooling is complete. A lifetime maximum of $10,000 can be withdrawn to pay the principal or interest on a qualified education loan. This benefit applies to the plan’s beneficiary. The same $10,000 lifetime limit can also be applied to each of the beneficiary’s siblings, offering a measure of flexibility for families with multiple children.

Apprenticeship Programs

Recognizing the value of vocational training, the rules permit withdrawals for expenses related to registered apprenticeship programs. Funds can be used to pay for fees, books, supplies, and equipment required for participation. To qualify, the apprenticeship program must be registered and certified with the Secretary of Labor under the National Apprenticeship Act. This allows the plan to support a broader range of career paths beyond traditional four-year college degrees.

Tax Implications of Non-Qualified Withdrawals

When funds are withdrawn for any reason other than a qualified education expense, the withdrawal is considered non-qualified. This means it loses its preferential tax treatment. The penalties are applied only to the earnings portion of the withdrawal, not the original contributions.

Federal Tax Consequences

The earnings portion of a non-qualified withdrawal is subject to federal income tax at the recipient’s rate. In addition, the earnings are hit with a 10% federal penalty tax. For example, if a withdrawal is taken from an account where 25% of the balance is earnings, then 25% of that withdrawal is considered earnings and is subject to both income tax and the penalty.

North Carolina State Tax Consequences

North Carolina also applies tax consequences to non-qualified withdrawals. The earnings portion is subject to state income tax. Additionally, any state income tax deductions taken for contributions before 2014 are subject to recapture. This means the value of those prior deductions must be added back to the taxpayer’s North Carolina taxable income in the year of the non-qualified withdrawal.

Rollovers to a Roth IRA

A recent change provides a new option for unused funds in an NC 529 account, allowing for a tax-free and penalty-free rollover to a Roth IRA. This allows beneficiaries to repurpose their educational savings for retirement without facing the negative tax consequences of a non-qualified withdrawal.

This option is subject to several conditions. The 529 account must have been open for a minimum of 15 years. The rollover must be made to a Roth IRA in the name of the 529 plan’s beneficiary. The amount that can be rolled over is subject to a lifetime maximum of $35,000 and is also limited by the beneficiary’s annual Roth IRA contribution limit for that year.

The Withdrawal Process

The account owner is authorized to request a withdrawal at any time. The destination of the payment has implications for tax reporting. Withdrawals can be requested through the secure online portal or by submitting a Withdrawal Request Form.

For a qualified withdrawal, there are three payment destinations. Funds can be paid to the account owner as a reimbursement, directly to the beneficiary, or directly to the eligible educational institution. The recipient of the funds (or the beneficiary, if paid to the school) receives IRS Form 1099-Q, which reports the distribution. For non-qualified withdrawals, payment is made to the account owner, who is responsible for any tax consequences.

Recordkeeping for Withdrawals

Proper documentation is required to prove to the IRS and the North Carolina Department of Revenue that a withdrawal was used for qualified education expenses. Without proof, a withdrawal could be reclassified as non-qualified and become subject to taxes and penalties. Account owners must keep detailed records that align with the amounts reported on Form 1099-Q.

This includes saving all relevant receipts and invoices. For higher education, this means keeping tuition statements, bookstore receipts, technology invoices, and housing contracts. For K-12 tuition, the school’s tuition bill is the primary document.

These records should show that the amount withdrawn corresponds to a qualified expense paid in the same calendar year. It is advisable to keep these records for at least three years after filing the tax return for the year of the withdrawal.