After years of saving for your child’s college education, the moment has arrived to tap into your 529 Savings Plan. However, withdrawing the funds correctly and for eligible expenses is crucial if you want to maximize the value of your investment. Even if you need a deeper understanding of the intricacies of 529 withdrawals, there are a few key pieces of information you should be aware of.
- A distinction exists between expenses that are considered qualified and those that are non-qualified.
- There exist strategies or exceptions that permit non-qualified withdrawals to be made without incurring penalties.
- Making a non-qualified withdrawal can have significant impacts.
Gaining an understanding of the consequences of withdrawing from your 529 can aid in the effective planning of your child’s future and college education.
Note
You have the option to withdraw the principal amount you initially invested from your 529 without incurring a penalty. However, any earnings on the investment are subject to taxation, and if you have contributed after-tax money, they are also subject to a 10% penalty.
Where Can My 529 Plan Be Spent?
The 529 plan provides specific guidelines for expenditure to avail of the 529 tax benefits and other advantages. The funds you have accumulated can be utilized for educational expenses that are directly associated with your educational costs. These expenses may include the following:
Tuition and Fees
It is possible to use 529 plans to cover the cost of tuition and fees for both full-time and part-time students.
Room and Board
Regardless of whether you reside on-campus or off, your room-and-board expenses can be covered by your 529 plan funds. However, it is important to note that if you wish to use 529 funds for off-campus housing, the cost should not exceed what you would pay to live on campus.
Required Textbooks and Supplies
You can utilize your 529 plan funds to cover the expenses of the books listed in your course syllabus, as well as the supplies necessary for your classes.
Technology
When it comes to college necessities, your 529 plan funds can cover the cost of a new computer or tablet, internet service, and even a printer.
Special Needs and Adaptive Equipment
Devices that are essential for attending classes, navigating around the campus, or participating in lectures can be paid for using 529 plan funds. Although transportation expenses are typically not covered, if you have special needs, your transportation expenses may be considered eligible expenses.
It’s important to note that these eligible expenses can pertain to any educational institution that meets the criteria for federal financial student aid. This encompasses both public and private institutions throughout the United States, as well as some overseas institutions. Eligible institutions also include undergraduate and graduate schools, as well as select trade schools.
Non-Qualified 529 Expenses
While your 529 savings are intended for college expenses, there are certain expenditures that may not qualify for coverage, even if they are related to your academic pursuits or coursework. Some examples of these non-qualified expenses include:
Transportation
It’s important to note that your 529 savings cannot be used to cover transportation expenses such as car payments, bus fare, airfare, or gasoline, even if these expenses are incurred in order to get to college.
Student Loan Costs
It’s worth noting that you cannot use your 529 plan savings to pay off your student loans or cover the interest on them.
Sports or Activities
It’s important to keep in mind that expenses associated with athletics, sports clubs, school-sponsored groups, or campus events are not eligible for coverage using 529 plan funds.
Health Insurance
It’s worth noting that medical expenses and health insurance costs incurred during your time in school are not eligible for coverage using 529 savings.
529 Withdrawal Exceptions
While the rules regarding 529 withdrawals are generally rigid, there are certain methods to make non-qualified withdrawals without incurring the 10% penalty. These include:
- The student beneficiary receives a scholarship
- The student beneficiary dies
- The student beneficiary enrolls in a U.S. service academy
It’s important to note that in such circumstances, you may still be required to pay income taxes on the gains unless the funds are utilized for qualified expenses. Additionally, if you have multiple children and one of them receives a scholarship or any other exemption, you may choose to change the beneficiary of your 529 plan accordingly.
In the event that your eldest child wins a scholarship or decides to attend a U.S. service academy, you may withdraw the funds from your 529 plan without penalty, although taxes on gains will still apply. Alternatively, you can opt to change the beneficiary to one of your younger children, which would not incur any penalties, and that child would receive the full amount of your 529 plan savings.
Strategies Before You Make a Non-Qualified Withdrawal
Given that non-qualified withdrawals are typically subject to penalties, it’s essential to carefully evaluate all of your options before making a decision. In many situations, there may be alternative strategies that enable you to retain more of the funds you’ve diligently saved. Prior to pursuing a non-qualified withdrawal, it’s crucial to take the following factors into account.
- Do you have other qualified expenses coming up? Paying for books, rent, and supplies would be a better option for these funds, and they won’t be penalized.
- Will your child go on to grad school? If your child plans to pursue further study in the field of medicine, law, or grad school, your 529 savings can also be used for these expenses.
- Can you choose another beneficiary? Changing the beneficiary of your 529 plan to a younger child can be a viable option that allows you to save on penalties and contribute to jump-starting that family member’s college savings.
- Can you withdraw from the principal? Withdrawing only the amount you invested without incurring a penalty while leaving the growth untouched is a feasible way to avoid fines and retain some of the funds you’ve accumulated.
Possible 529 Withdrawal Penalties
The key point to keep in mind regarding penalties and your 529 plan is that you can withdraw your principal without penalty at any time. However, any earnings or growth on your investments may be subject to penalties if they are not used for qualified education expenses. It’s worth noting that unlike traditional investment accounts, the growth of your 529 plan is treated and taxed as income, not capital gains.
Withdrawing funds from your 529 plan for non-qualified expenses will result in a 10% penalty on any earnings. In addition, you will be required to pay income taxes on the earnings, and in some cases, you may have to reimburse any state income tax deductions that you previously claimed.
A thorough understanding of the distinctions between qualified and non-qualified expenses and taking measures to reduce penalties before making any withdrawals can help you retain as much of your hard-earned investment as possible, considering that penalties apply to non-qualified withdrawals.
Ready to Withdraw?
After years of saving, the long-awaited day has arrived, but what’s next? First, determine the amount you require for your qualified expenses. It’s advisable to have a clear estimate of how much you will need after accounting for any financial aid and scholarships you have been awarded.
Once you have determined the required amount, the next step is to decide who gets the funds. You can send the funds directly to the college, add them to your accounts for paying expenses or release them to your student (the account beneficiary). Save any receipts, bills, and other documentation for tax time.
Once you have determined the required amount, the next step is to decide who gets the funds. You can send the funds directly to the college, add them to your accounts for paying expenses or release them to your student (the account beneficiary). Save any receipts, bills, and other documentation for tax time.
