How Much Can You Withdraw From a 529 Plan Per Year?

A 529 plan is a savings account designed to encourage saving for future education costs. It offers tax advantages, as the money can grow without being subject to federal taxes, and withdrawals for qualified education expenses are also tax-free. However, these plans operate under specific regulations concerning how and when money can be taken out to avoid tax liabilities.

The Annual Withdrawal Limit Tied to Qualified Expenses

The Internal Revenue Service (IRS) does not set a specific dollar amount as a yearly withdrawal limit for higher education. Instead, the maximum amount you can withdraw tax-free is determined by the beneficiary’s Adjusted Qualified Higher Education Expenses (AQHEE) for that calendar year. To find this amount, you must first total all Qualified Higher Education Expenses (QHEE) and then subtract any tax-free educational assistance the student received, such as scholarships or grants.

QHEE includes a range of costs required for enrollment or attendance at an eligible educational institution. These include tuition and mandatory fees, books, supplies, and equipment needed for courses. Room and board costs also qualify for students enrolled at least half-time. For students in university-owned housing, the qualified amount is what the school charges. For off-campus students, the allowance is limited to the amount the school includes in its official cost of attendance.

Certain technology-related purchases are also considered qualified expenses, including computers, peripheral equipment, computer software, and internet access, provided they are used primarily by the beneficiary during enrollment. However, some common student-related costs are not qualified. These non-allowable expenses include transportation to and from campus, student loan payments, and health insurance fees. A separate lifetime limit of $10,000 may apply for using 529 funds for loan repayment.

Calculating and Timing Your Withdrawal Amount

The timing of your withdrawal is as important as the amount. A primary rule is that distributions from a 529 plan must be taken in the same calendar year that the corresponding expenses were paid. For example, if you pay a tuition bill in December for the spring semester, you must take the 529 withdrawal in that same year to align with the payment date, not the academic period.

To support your withdrawals, you should retain all documents related to educational expenses. This includes itemized tuition bills from the college, receipts for textbooks and required supplies, and statements for room and board. In the event of an IRS inquiry, this documentation will be needed to substantiate the tax-free nature of your 529 plan distributions.

How to Request a 529 Plan Distribution

To request funds from your 529 plan administrator, you can log into your online account portal or complete a distribution request form. Most plans offer several methods for distribution.

One common method is to have the payment sent directly to the educational institution. This option creates a clear paper trail showing the funds were used for their intended purpose. The 529 plan administrator will issue a payment to the college or university on behalf of the student beneficiary.

Another option is to have the funds paid to the account owner, which is often used as a reimbursement for expenses you have already paid out-of-pocket. If you choose this method, you must be able to document that you have already paid the qualified expenses. The plan administrator will transfer the requested amount to your personal bank account.

A third choice is to have the distribution sent directly to the student beneficiary. This can be a convenient way to provide the student with funds for their own qualified expenses, such as books, supplies, or off-campus housing costs.

Tax Consequences of Non-Qualified Distributions

Withdrawing funds from a 529 plan for anything other than AQHEE results in a non-qualified distribution, which has specific tax implications. While you can access your contributions at any time without tax or penalty, the earnings portion of a non-qualified withdrawal is subject to both income tax and an additional penalty.

The earnings portion of a non-qualified withdrawal is taxed as ordinary income at the recipient’s tax rate. In addition to the income tax, the IRS imposes a 10% federal tax penalty on these earnings. For instance, if you take a $5,000 non-qualified withdrawal, and $2,000 of that amount is considered earnings, the $2,000 will be subject to both ordinary income tax and a $200 penalty.

There are a few situations where the 10% penalty on a non-qualified withdrawal may be waived, although income tax on the earnings still applies. These exceptions include cases where the beneficiary has died or become disabled. The penalty is also waived on withdrawals up to the amount of a tax-free scholarship the beneficiary received.

A New Option for Unused Funds: Roth IRA Rollovers

A recent change in rules offers new flexibility for unused 529 plan funds. Beneficiaries can now roll over money from a long-term 529 account to a Roth IRA without facing taxes or penalties.

This rollover is subject to several conditions:

• There is a lifetime limit of $35,000 per beneficiary.
• The 529 account must have been open for more than 15 years.
• The specific funds being transferred must have been in the account for at least five years.
• The amount rolled over in any given year cannot exceed the annual Roth IRA contribution limit.