How to Use 529 Funds for College Expenses

A 529 plan is a tax-advantaged savings account designed to help families pay for education expenses. The funds can be used for college-related costs, but specific rules ensure withdrawals remain tax-free. Misusing the funds can lead to penalties and unexpected taxes.

Understanding how to properly use 529 funds helps maximize their benefits while avoiding costly mistakes.

Approved Institutions

Not all schools qualify for 529 plan withdrawals. Eligible institutions participate in federal student aid programs under Title IV of the Higher Education Act. This includes most accredited public and private colleges, universities, vocational schools, and some international institutions. Families can check a school’s status through the Federal School Code List maintained by the U.S. Department of Education.

While four-year universities are common, 529 funds can also be used at community colleges, trade schools, and apprenticeship programs registered with the U.S. Department of Labor. Some professional certification programs may qualify if offered by an eligible institution.

Many foreign universities, particularly in Canada, the United Kingdom, and Australia, participate in the U.S. federal student aid system, making them eligible for 529 funds. It’s important to confirm eligibility with the plan administrator before making withdrawals.

Qualified Education Costs

To ensure tax-free withdrawals, funds must be used for qualified education expenses, including tuition, room and board, and required supplies. Non-qualified expenses result in income tax on earnings and a 10% penalty.

Tuition

Tuition is a primary expense covered by 529 plans. Funds apply to undergraduate, graduate, and professional degree programs at eligible institutions. The amount withdrawn must match the actual tuition charged.

For example, if a public university charges $12,000 per year for in-state tuition and the student receives a $6,000 scholarship, only the remaining $6,000 can be withdrawn tax-free. Excess withdrawals are subject to taxes and penalties unless used for other qualified expenses.

Prepaid tuition plans allow families to lock in current tuition rates, typically for in-state public institutions. Transferring funds to an out-of-state or private school may result in adjustments to the plan’s value.

Room and Board

Housing and meal costs qualify if the student is enrolled at least half-time. 529 funds cover on-campus housing and meal plans, as well as off-campus rent and groceries, but there are limits. The maximum tax-free withdrawal for off-campus living is based on the school’s published cost of attendance.

For instance, if a university estimates off-campus housing at $10,000 per year and a student’s rent and utilities total $12,000, only $10,000 can be withdrawn tax-free. The additional $2,000 would be considered a non-qualified expense.

Receipts and lease agreements should be kept to document expenses in case of an IRS audit. If a student lives at home, 529 funds cannot be used for rent or food, as these costs are not considered additional education expenses.

Required Supplies

Books, software, and other necessary materials qualify for tax-free withdrawals if required by the institution.

For example, if a university mandates a $200 textbook for a course, a 529 withdrawal for that amount is allowed. However, an additional study guide that is not required would not qualify. A laptop is eligible if the school requires students to have one, but a high-end gaming computer purchased for personal use would not be covered.

Other eligible expenses include lab equipment, art supplies, and software for coursework. Internet access may qualify if essential for online classes, but general household utilities do not. Keeping receipts and course syllabi that list required materials helps substantiate withdrawals if questioned.

Tax Considerations

A key advantage of a 529 plan is its tax-free growth and withdrawals for qualified expenses. Contributions are not deductible on federal tax returns, though many states offer tax benefits for residents who contribute to their state’s plan. Some states allow deductions of up to $20,000 for married couples filing jointly.

Investment growth within a 529 plan is tax-deferred, meaning earnings are not taxed while in the account. Non-qualified withdrawals result in income tax on earnings and a 10% penalty. Exceptions exist, such as when the beneficiary receives a scholarship. In that case, withdrawals up to the scholarship amount are taxable but avoid the penalty.

Contributions to a 529 account are considered gifts for tax purposes. In 2024, individuals can contribute up to $18,000 per beneficiary ($36,000 for married couples) without triggering gift tax consequences. A unique feature allows contributors to front-load five years’ worth of gift tax exclusions, permitting a single contributor to deposit up to $90,000 ($180,000 for couples) in one year without incurring gift taxes, provided no additional gifts are made to the beneficiary during that period. This strategy is useful for grandparents or relatives looking to transfer wealth while reducing their taxable estate.

Distribution Timing and Documentation

Managing the timing of 529 withdrawals is necessary to avoid tax complications. Distributions must occur in the same calendar year as the corresponding education expenses. If a withdrawal is taken in December to pay for tuition due in January, or if an expense is paid in December but reimbursed with a withdrawal in January, it could result in a taxable event. Aligning withdrawals with actual payment dates is recommended.

Accurate documentation is just as important. Schools issue Form 1098-T, which reports tuition and related costs, but this form may not capture all eligible expenses. Keeping detailed records such as invoices, receipts, and bank statements helps substantiate withdrawals if questioned. Maintaining a log of expenses tied to each withdrawal simplifies reporting and prevents errors that could trigger an audit.

Coordination With Financial Aid

Using 529 plan funds can impact need-based financial aid. The way 529 assets and withdrawals are reported influences the Expected Family Contribution (EFC), which determines financial aid eligibility.

If a 529 plan is owned by a dependent student or their parents, it is considered a parental asset and assessed at a maximum rate of 5.64% when calculating aid eligibility. This is significantly lower than the 20% rate applied to student-owned assets, making parent-owned 529 plans a more favorable option. Withdrawals from a parent-owned 529 plan do not count as student income, ensuring they do not negatively impact aid eligibility.

However, if a 529 plan is owned by a grandparent or another relative, distributions are treated as untaxed student income on the FAFSA, which can reduce aid eligibility by up to 50% of the withdrawn amount. To avoid this, families may delay grandparent-owned 529 withdrawals until after the student files their final FAFSA, typically in their junior year of college.

Rollover to Other Educational Accounts

If a student does not use all the funds in a 529 plan, rolling the remaining balance into another educational savings account can help avoid taxes and penalties while preserving the money for future use.

One option is rolling over funds into a 529 ABLE account, designed for individuals with disabilities. This allows families to transfer up to the annual ABLE contribution limit—$18,000 in 2024—without incurring taxes or penalties. ABLE accounts provide tax-free growth and withdrawals for disability-related expenses.

Another option, introduced by the SECURE 2.0 Act, permits rollovers from a 529 plan to a Roth IRA for the beneficiary, subject to a lifetime limit of $35,000. To qualify, the 529 account must have been open for at least 15 years, and contributions made within the last five years are ineligible for rollover. This provision allows families to repurpose excess funds for retirement savings.