How Can 529 Funds Be Used for Qualified Expenses?

A 529 plan serves as a tax-advantaged savings vehicle designed to assist individuals and families in saving for future education costs. These plans offer a beneficial way to accumulate funds over time, with potential tax advantages on earnings when distributions are used for specific educational purposes.

Qualified Education Expenses

Funds saved within a 529 plan can be used to cover a range of qualified education expenses, as defined by federal tax law. These expenses must be incurred at an eligible educational institution, which includes most accredited public, private, and non-profit colleges, universities, vocational schools, and other postsecondary institutions.

Tuition and fees represent direct costs associated with enrollment or attendance at an eligible educational institution. This includes charges for courses, enrollment, and other mandatory fees required for a student to attend the institution.

Room and board expenses also qualify, provided the student is enrolled at least half-time in a degree or certificate program. For students living in on-campus housing, the actual cost of the room and board charged by the institution qualifies. If the student lives off-campus, the qualified amount for room and board cannot exceed the allowance for room and board determined by the eligible educational institution for federal financial aid purposes.

Books, supplies, and equipment necessary for enrollment or attendance at an eligible educational institution are also considered qualified expenses. This category can encompass a variety of items, from textbooks and notebooks to specific art supplies or laboratory equipment required for a course. Additionally, the cost of computers, peripheral equipment, computer software, and internet access services can qualify if these items are primarily used by the beneficiary during their enrollment period.

Expenses for special needs services can be paid with 529 funds when they are incurred in connection with enrollment or attendance at an eligible educational institution. These services must be required for a special needs beneficiary to attend the institution.

Recent legislative changes have expanded the scope of qualified expenses to include tuition for elementary or secondary public, private, or religious schools. This allows for up to $10,000 per student per year to be withdrawn tax-free from a 529 plan for K-12 tuition costs.

Expenses for registered apprenticeship programs are also now considered qualified education expenses. This includes fees, books, supplies, and equipment required for enrollment or attendance in such programs. The apprenticeship program must be registered with the Secretary of Labor under the National Apprenticeship Act to qualify.

529 funds can be used to repay qualified student loans, subject to certain limitations. A lifetime maximum of $10,000 can be used to repay the qualified student loans of the beneficiary. An additional $10,000 lifetime limit applies to repay the qualified student loans of each of the beneficiary’s siblings.

A more recent provision allows for limited rollovers from 529 plans to Roth IRAs, offering another avenue for using accumulated funds. To qualify, the 529 account must have been open for at least 15 years. The rollover amount is also subject to the annual Roth IRA contribution limits for the year of the rollover, and there is a lifetime maximum rollover limit of $35,000 per beneficiary.

Non-Qualified Distributions and Penalties

When 529 plan funds are withdrawn and not used for qualified education expenses, the distribution is generally considered non-qualified. Such distributions trigger specific tax consequences that can diminish the overall financial benefit of the plan.

The earnings portion of a non-qualified distribution is subject to federal income tax at the recipient’s ordinary income tax rate. This means any investment gains accrued within the 529 plan that are not used for qualified expenses will be taxed as regular income.

The principal portion of the distribution, representing the original contributions, is not subject to income tax because it was contributed with after-tax dollars.

In addition to income tax, a 10% federal penalty tax typically applies to the earnings portion of a non-qualified distribution. This penalty is designed to discourage the use of 529 funds for non-educational purposes.

Certain exceptions exist where the 10% penalty tax may be waived. These exceptions include distributions made due to the death or disability of the beneficiary. The penalty is also waived if the beneficiary receives a tax-free scholarship, grant, or other tax-free educational assistance, or if they attend a U.S. military academy. In these specific circumstances, while the earnings may still be subject to ordinary income tax, the additional 10% penalty is not imposed.