What Are Tax-Free Distributions From a 529 Plan?

A 529 plan is a tax-advantaged savings account for future education costs. The primary benefit is that investments grow on a tax-deferred basis, meaning no income tax is paid on the earnings as they accumulate. When the funds are used, distributions are free from federal income tax if the money is used for specific, approved purposes. These funds can be used at eligible institutions, including colleges, universities, and vocational schools. Understanding the rules for what constitutes a tax-free distribution is necessary to maximize the plan’s benefits and avoid taxes or penalties.

Defining Qualified Education Expenses

Qualified Higher Education Expenses (QHEE)

The largest category of tax-free withdrawals covers Qualified Higher Education Expenses (QHEE), which are expenses required for enrollment or attendance at an eligible postsecondary institution. QHEE includes tuition and mandatory fees for undergraduate and graduate programs. Funds can also be used for books, supplies, and equipment required for a student’s courses. This extends to a computer, peripheral equipment, computer software, and internet access, as long as these items are used primarily by the beneficiary during enrollment.

Room and board costs are also considered qualified, but with specific limitations. The student must be enrolled at least half-time for the expense to qualify. The amount cannot be more than the allowance for room and board included in the school’s official cost of attendance or the actual amount charged for on-campus housing.

K-12 Tuition

Account holders can take a tax-free distribution of up to $10,000 per beneficiary, per year, to pay for tuition at an eligible elementary or secondary school, including public, private, or religious institutions. This provision applies only to tuition, as other K-12 costs like uniforms or transportation are not qualified expenses.

Apprenticeship Programs

Tax-free distributions can cover expenses for participation in apprenticeship programs registered and certified with the Secretary of Labor under the National Apprenticeship Act. Qualified expenses for these programs include required fees, books, supplies, and equipment.

Student Loan Repayments

A lifetime limit of $10,000 can be withdrawn tax-free to pay the principal or interest on a qualified education loan. This benefit applies to the 529 plan’s beneficiary and can also be used for the beneficiary’s siblings. The $10,000 limit is a lifetime total per individual, not an annual amount.

The 529 to Roth IRA Rollover

Introduced by the SECURE 2.0 Act, a provision allows unused 529 plan funds to be rolled over into a Roth IRA for the beneficiary without tax or penalties. This allows leftover education savings to be repurposed for retirement.

To execute a tax-free rollover, several conditions must be met:

• The 529 account must have been open for a minimum of 15 years.
• The rollover must be made into a Roth IRA in the name of the 529 plan’s beneficiary.
• A lifetime maximum of $35,000 can be moved from a 529 account to a Roth IRA for any single beneficiary.
• The amount rolled over in any given year is subject to the annual Roth IRA contribution limits for that year.
• Contributions made to the 529 plan within the last five years, and the earnings on those contributions, are not eligible to be rolled over.

Understanding Non-Qualified Distributions

A withdrawal for any reason other than a qualified education expense or an eligible rollover is considered non-qualified. For a non-qualified distribution, only the earnings portion is subject to federal income tax and a 10% penalty. The portion of the withdrawal that represents original contributions (the basis) is returned tax-free.

For example, on a $10,000 non-qualified distribution with $4,000 in earnings, only the $4,000 is affected. This amount is added to your taxable income for the year, and you would also owe a $400 federal penalty (10% of $4,000).

The plan administrator issues IRS Form 1099-Q to the recipient, reporting the total distribution and breaking it down into earnings and basis. This form is used to report the taxable income on a tax return. Some states may also impose their own taxes or penalties on non-qualified distributions.

Process and Recordkeeping for Distributions

Most plans allow you to request that payment be sent to you, the student beneficiary, or the educational institution. Sending payment to the school or beneficiary can simplify tax reporting, as the Form 1099-Q is issued in the student’s name, which may result in a lower tax liability if any part of the distribution is taxable.

To ensure a distribution is tax-free, it must be taken in the same calendar year that the qualified expense was paid. For instance, a tuition bill paid in December 2024 requires the 529 withdrawal to also occur in 2024. Mismatched timing can cause the withdrawal to be treated as non-qualified.

You must coordinate 529 distributions with other education tax benefits to avoid “double-dipping.” Expenses paid with tax-free 529 funds cannot also be used to claim credits like the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC). For example, with $10,000 in qualified expenses, you could use $4,000 of tuition to claim the AOTC and the remaining $6,000 to justify a tax-free 529 distribution.

In case of an IRS audit, you must be able to prove that distributions were used for qualified expenses. You should retain documentation like tuition statements, receipts for required books and equipment, and housing or meal plan bills. Keeping these records for at least three years after the distribution will provide the necessary proof to support the tax-free status of your withdrawals.