Can You Take Money Out of a College Fund?

Many individuals and families establish specialized college funds, which offer distinct advantages, often including tax benefits, to encourage saving for future learning expenses. Understanding the specific rules and implications for withdrawals is important to maximize benefits and avoid unintended consequences.

Understanding Different College Savings Accounts

Various types of college savings vehicles exist, each with its own structure and tax treatment. Identifying the specific account type is the initial step in comprehending withdrawal rules. Two prominent tax-advantaged options are 529 plans and Coverdell Education Savings Accounts (ESAs), while Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts offer a different approach to saving for a minor’s future.

A 529 plan is a state-sponsored investment vehicle specifically designed to help families save for education. The account is owned by an adult, such as a parent or grandparent, who maintains control over the funds regardless of the beneficiary’s age. Contributions grow tax-deferred, and qualified withdrawals are entirely federal income tax-free, with many states also offering tax benefits.

Coverdell ESAs, sometimes known as Education IRAs, also offer tax-deferred growth and tax-free withdrawals for qualified education expenses. These accounts have a lower annual contribution limit, typically $2,000 per beneficiary, and may have income eligibility restrictions for contributors. Unlike 529 plans, Coverdell ESAs allow for a broader range of K-12 education expenses.

In contrast, UGMA and UTMA accounts are custodial accounts where gifts are irrevocably made to a minor. The minor legally owns the assets, but an adult custodian manages the account until the minor reaches the age of majority, typically 18 or 21, depending on state law. These accounts are not specific to education and can be used for any purpose that benefits the minor.

Qualified Education Expenses Defined

For tax-advantaged education savings plans like 529 plans and Coverdell ESAs, the Internal Revenue Service (IRS) strictly defines what constitutes “qualified education expenses.” Using funds for these specific expenses allows withdrawals to be tax-free. Expenses that fall outside of this definition can lead to taxes and penalties.

Qualified expenses generally include tuition and fees required for enrollment or attendance at an eligible educational institution. This broad category covers most colleges, universities, vocational schools, and other postsecondary institutions eligible for federal student aid programs. Books, supplies, and equipment necessary for enrollment or attendance are also considered qualified. This includes computer technology, related equipment, and internet services if used by the beneficiary and their family during their enrollment.

For students enrolled at least half-time, room and board expenses qualify, but there are limitations. The amount cannot exceed the allowance for room and board determined by the educational institution for financial aid purposes, or the actual amount charged by the institution if the student lives in on-campus housing. Special needs services required by a special needs beneficiary also qualify as an education expense.

Recent legislative changes expanded qualified expenses for 529 plans to include up to $10,000 per year for K-12 tuition. Costs associated with registered apprenticeship programs and up to $10,000 in student loan repayments per beneficiary, and an additional $10,000 for each of the beneficiary’s siblings, also qualify.

Making Withdrawals from 529 Plans

Withdrawing funds from a 529 plan requires adherence to specific procedures and an understanding of tax implications based on the use of funds. When withdrawals are used for qualified education expenses, as previously defined, they are entirely free from federal income tax. Many states also offer tax-free treatment for these qualified distributions.

Account holders should track and match withdrawals to expenses within the same calendar year to ensure compliance. Most 529 plan administrators provide online portals or forms to initiate withdrawal requests, allowing direct payments to the educational institution or reimbursement. Maintaining detailed records, such as receipts, is important in case the IRS requires proof of qualified expenses.

If funds are withdrawn for non-qualified expenses, the earnings portion becomes subject to federal income tax and a 10% federal penalty tax. Exceptions may waive the penalty, such as the beneficiary receiving a scholarship, becoming disabled, or attending a U.S. military academy; however, earnings may still be taxable.

529 plans offer flexibility beyond direct educational use, allowing for changes in beneficiary to another eligible family member without tax consequences. Funds can also be rolled over to another 529 plan for the same or a different eligible beneficiary. Recent provisions also permit rolling over up to $35,000 from a 529 plan into a Roth IRA for the beneficiary, provided certain conditions are met, offering another avenue for unused funds.

Making Withdrawals from Coverdell ESAs

Accessing funds from a Coverdell ESA involves specific rules, including age limitations and tax considerations for both qualified and non-qualified withdrawals. When Coverdell ESA funds are used for qualified education expenses, the withdrawals, including any earnings, are entirely federal income tax-free. This tax-free benefit extends to a wide range of K-12 expenses, such as tuition, books, supplies, equipment, and even academic tutoring.

A unique aspect of Coverdell ESAs is the age restriction for the beneficiary. Generally, the funds must be used or rolled over to another eligible family member by the time the beneficiary reaches age 30. If funds remain unused or not properly rolled over past this age, the earnings portion of the remaining balance becomes taxable and is subject to a 10% federal penalty tax. An exception to this age limit exists for beneficiaries with special needs.

Non-qualified withdrawals from a Coverdell ESA are subject to ordinary income tax on the earnings. A 10% federal penalty tax also applies to the earnings portion of these distributions, similar to 529 plans. This penalty can be waived under specific circumstances, such as the beneficiary receiving a scholarship or becoming permanently disabled.

The process for requesting withdrawals from a Coverdell ESA typically involves contacting the account administrator. It is important to maintain thorough documentation, such as receipts and invoices, to prove that withdrawals were used for qualified educational expenses. Coverdell ESAs also allow for changing the beneficiary to another eligible family member or rolling over funds to another Coverdell ESA or even into a 529 plan, providing flexibility for unused funds.

Accessing Funds from Custodial Accounts (UGMA/UTMA)

Custodial accounts, established under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), operate differently from tax-advantaged education savings plans. These accounts are not specifically designed for education; rather, they hold irrevocable gifts made to a minor. Once assets are contributed, they legally belong to the minor and cannot be reclaimed by the donor.

The custodian, typically a parent, manages the account until the minor reaches the age of majority, which varies by state but is commonly 18 or 21. At this point, the minor gains full legal control over the funds and can use them for any purpose. There are no “qualified education expenses” for UGMA/UTMA accounts, meaning funds can be used for a wide range of expenses that benefit the minor, such as summer camps, a car, or general living expenses, without incurring penalties for non-educational use.

Regarding taxation, the earnings within UGMA/UTMA accounts are generally taxed annually at the minor’s tax rate. This is often lower than the parent’s rate, though the “kiddie tax” rules apply to unearned income exceeding certain thresholds. For example, in 2025, the first $1,350 of unearned income may be tax-free, the next $1,350 taxed at the child’s rate, and amounts over $2,700 taxed at the parent’s marginal rate.

When the minor withdraws funds, the principal portion is not taxed again, as the earnings were already taxed annually. Custodians can typically request withdrawals online or by phone, and funds can be sent directly to a bank account or to an institution for the minor’s benefit.