How to Pay Tuition From Your 529 Plan

A 529 plan is a tax-advantaged savings vehicle for education. Authorized by Internal Revenue Code Section 529, these plans are sponsored by states or educational institutions. Contributions grow tax-deferred, and qualified withdrawals are exempt from federal and often state income tax.

Understanding Qualified Education Expenses

529 plan funds cover “qualified education expenses” (QEEs). They include tuition and fees at eligible postsecondary institutions participating in federal student aid programs. Tuition for elementary and secondary public, private, or religious schools also qualifies, with an annual limit of up to $10,000 per beneficiary.

Qualified expenses include books, supplies, and equipment. Room and board costs qualify if the student is enrolled at least half-time, but for off-campus housing, these expenses cannot exceed the allowance determined by the educational institution’s cost of attendance. Special needs services, computer technology, software, and internet access also qualify. Additionally, 529 plans can cover registered apprenticeship programs and up to $10,000 in principal or interest on qualified student loans per beneficiary over their lifetime.

Not all costs qualify. Transportation, insurance, and general living expenses are not QEEs. Fees for extracurricular activities or health insurance do not qualify. Using 529 funds for non-qualified expenses can lead to significant tax consequences; review IRS guidelines to avoid them.

Withdrawing Funds

Withdrawal requests from a 529 plan are made through the plan administrator’s online portal, by phone, or by submitting a physical form. Most plans offer electronic payments, which can expedite the process, often arriving at the educational institution within a few business days.

When requesting a distribution, account holders have options. Funds can be sent directly to the educational institution, paid to the 529 account holder as reimbursement, or sent directly to the beneficiary. For K-12 tuition withdrawals, some plans may only send funds to the account owner, not directly to the school or beneficiary.

Distributions should occur within the same tax year that qualified education expenses are incurred. For instance, if tuition is paid in December, the 529 withdrawal should happen in December, even if the semester extends into the next calendar year. If tuition for a spring semester is due in January, the withdrawal should be made in January, not December of the prior year. Maintain records of all qualified education expenses and corresponding 529 withdrawals for tax compliance; the IRS may request them to verify qualified use.

Tax Implications of Withdrawals

Withdrawals from a 529 plan are federal income tax-free when used for qualified education expenses. This applies to contributions and earnings, making 529 plans an effective tool.

However, if withdrawals are not used for qualified education expenses, they are “non-qualified distributions.” The earnings portion is subject to federal income tax at the recipient’s ordinary rate. A 10% federal penalty tax is assessed on earnings. This penalty aims to discourage the use of these tax-advantaged funds for non-educational purposes.

The 10% federal penalty tax may be waived, though the earnings portion may still be taxable. Exceptions include:
Death or disability of the beneficiary.
Beneficiary receives a tax-free scholarship, up to the scholarship amount.
Attendance at a U.S. military academy.
Expenses used to justify certain federal education tax credits.

State tax implications vary; many states follow federal tax treatment for qualified withdrawals, but some have different rules or recapture previously granted state tax benefits on non-qualified withdrawals.

Reporting 529 Plan Distributions

After 529 plan funds are distributed, the plan administrator issues Form 1099-Q, “Payments from Qualified Education Programs.” It reports the gross distribution, earnings, and basis (contributions). Form 1099-Q is sent to the account holder or the beneficiary. If payment was made directly to the beneficiary or the educational institution for their benefit, the beneficiary receives the 1099-Q.

While qualified distributions are not taxable, Form 1099-Q is issued as a record. Taxpayers do not need to report tax-free distributions on their federal income tax return if withdrawals do not exceed qualified education expenses. Retain Form 1099-Q and all receipts for qualified expenses for IRS inquiry. If a portion of the 529 distribution was used for non-qualified expenses, the taxable earnings and any applicable penalty must be calculated and reported on the tax return, on Schedule 1 of Form 1040. The recipient reports the taxable portion.