How to Withdraw Money From a 529 Plan

A 529 plan is a tax-advantaged savings and investment vehicle sponsored by states or educational institutions. These plans encourage saving for future learning by offering tax benefits. Funds within a 529 plan grow tax-deferred, and withdrawals can be tax-free when used for qualified education expenses. Understanding the proper withdrawal procedures is important to fully realize these tax advantages.

Understanding 529 Withdrawals: Qualified vs. Non-Qualified

The tax treatment of a 529 plan withdrawal depends on their use for “qualified higher education expenses” (QHEEs). The Internal Revenue Service (IRS) defines these expenses, which include costs associated with eligible educational institutions. Common QHEEs include tuition and fees, books, supplies, and equipment required for enrollment or attendance. Room and board expenses also qualify if the student is enrolled at least half-time at an eligible educational institution.

Up to $10,000 per year per beneficiary can be withdrawn tax-free for tuition expenses at an elementary or secondary public, private, or religious school. A lifetime limit of $10,000 per beneficiary can also be used for qualified student loan repayments. Expenses for registered apprenticeship programs and special needs services for a beneficiary fall under the qualified category. Withdrawals must be made in the same tax year that the corresponding qualified expenses are incurred to maintain their tax-free status.

Withdrawals not used for QHEEs are considered “non-qualified distributions.” The earnings portion of these distributions becomes subject to federal income tax at the account owner’s or beneficiary’s ordinary income tax rate. A 10% federal penalty tax applies to the earnings portion of non-qualified withdrawals. This penalty discourages using 529 funds for non-educational purposes.

Certain circumstances may exempt a non-qualified withdrawal from the 10% federal penalty tax. These exceptions include the death or disability of the beneficiary. The penalty may also be waived if the beneficiary receives a tax-free scholarship, attends a U.S. military academy, or if the expenses were used to generate certain federal education tax credits, such as the American Opportunity Tax Credit or the Lifetime Learning Tax Credit.

Gathering Information and Documentation for a Withdrawal

Before initiating a 529 plan withdrawal, gather specific information and documentation. Having these details readily available streamlines the withdrawal process and helps ensure accuracy. The account owner should identify the precise 529 plan account number, the beneficiary’s full name, and relevant identifying information. Preparing the exact amount to be withdrawn is also necessary.

The purpose of the withdrawal must be clearly defined, specifying the qualified higher education expense category it will cover, such as tuition, room and board, or books. The account owner should also determine who will receive the funds, whether it is the account owner, the beneficiary, or directly to an educational institution.

Decide the preferred method of distribution in advance. If direct deposit is desired, bank account details, including routing and account numbers, will be required. For check disbursements, an accurate mailing address is necessary. Collect and retain all supporting documentation for qualified expenses, such as tuition bills, receipts, and housing invoices. These records are crucial for substantiating tax-free withdrawals if requested by the IRS during an audit.

Initiating a 529 Plan Withdrawal Request

The most common method for submitting a 529 plan withdrawal request is through the provider’s online portal. Account owners typically log into their online account, navigate to the withdrawal or distribution section, and follow the prompts. This digital process often includes fields for the withdrawal amount, the purpose of the funds, and the recipient’s details.

Many 529 plan providers offer alternative methods for requesting withdrawals. These may include submitting a paper withdrawal form, which can be downloaded from the provider’s website and sent via mail or fax. Some providers also facilitate withdrawal requests over the phone, where a representative can assist the account owner.

After the withdrawal request is submitted, the account owner can expect to receive a confirmation. Processing times for withdrawals can vary by provider and method, ranging from a few business days for direct deposits to longer for checks. Funds are usually disbursed through direct deposit to a specified bank account or by check mailed to the designated recipient.

Tax Reporting for 529 Distributions

Following a 529 plan distribution, the plan administrator is required to issue Form 1099-Q, “Payments from Qualified Education Programs (Under Sections 529 and 530).” This form is mailed to the account owner by January 31st of the year following the distribution. Form 1099-Q provides information for tax preparation.

The form will detail the gross distribution amount, the earnings portion of the distribution, and the basis (contributions) portion. This breakdown is important because only the earnings portion of a non-qualified withdrawal is subject to income tax and potential penalties. When preparing federal income taxes, Form 1099-Q information determines the taxable amount, if any, of the 529 distribution.

Maintain accurate and thorough records of all qualified higher education expenses. Although these records are not submitted with the tax return, they serve as substantiation for tax-free withdrawals in the event of an IRS inquiry or audit. These records should correspond to the amounts withdrawn from the 529 plan.