How to Withdraw Money From a 529 College Savings Plan
These moves can save you money and avoid costly penalties.
Parents who’ve been saving for their children’s college expenses for years know that putting money into a tax-advantaged 529 college savings account is easy, once the account has been set up. But they may not be as savvy about how best to take funds out.
Withdrawing funds from a 529 isn’t as straightforward as it sounds. And though money has continued to flow into these plans—assets stood at $431 billion in the first quarter of 2022, according to ISS Market Intelligence—many families still don’t fully understand how these accounts work.
Only 40 percent of Americans recognize 529 plans as a way to save for college, according to a recent survey by financial services firm Edward D. Jones. A 2021 survey found that even among those who do, 67 percent didn’t know about possible tax benefits and other features of 529 accounts.
If you have children heading to college this fall and plan to tap 529 funds to pay expenses, it’s important to withdraw the money correctly. A mistake could be costly: You could get hit with a 10 percent penalty, plus you’ll have to pay interest on the earnings for any funds that you use for the wrong kinds of expenses.
Here’s what you should keep in mind as you prepare to make withdrawals from a 529 college savings account.
Tilt Your Savings Toward Safety
Up till now, you’ve probably been investing your 529 account in a mix of stock and bond funds, or an age-based fund that holds both. But now that your child is entering college, you’ll want to make sure the money you’ll need for those costs is moved to safe investments, such as a money market fund.
Withdraw Funds Only for Qualified Expenses
You can use funds from a 529 account for a wide range of qualified education-related expenses. That includes tuition, fees, books, supplies, and computers.
The money can also go toward expenses for room and board, as long as the student is enrolled in school at least half-time. Dorm expenses are always covered, but if your child is living off campus, check the college’s “cost of attendance” figures to find out the amount that’s considered qualified for off-campus housing.
“You need to be careful about being able to document where your 529 money goes, in case the IRS asks questions,” says financial aid expert Kalman Chany, author of “Paying for College” (The Princeton Review, 2020).
Not all college-related bills are valid for 529 funds. Expenses such as transportation and insurance, for example, are not covered. If you’re unsure whether an expense qualifies, check with your plan provider.
Your 529 money can also be spent on expenses for K-12 education—up to $10,000 per student each year. But not every state will recognize elementary and secondary school expenses as qualified education costs, so check with your plan sponsor to find out what exactly is covered in the plan you choose.
And since the passage of the SECURE Act in 2019, 529 money can be used to repay up to $10,000 per beneficiary of qualified student loan debt. The legislation also permits 529 money to go toward eligible apprenticeship programs, as well as transfers to an ABLE account, a tax-free savings account designed to benefit children and adults with disabilities.
Time Your Payments
Keep in mind that you have to spend the money you take out of a 529 account in the same calendar year (not school year) as the withdrawal and that you should keep your receipts.
“Pay close attention to the timing of your withdrawals to ensure they match the expenses you pay, especially around year end,” says Kevin Hegarty, a certified financial planner in Garden City, N.Y.
If you paid the spring tuition bill in December out of your own savings, for example, then reimbursed yourself from a 529 plan withdrawal in January, that would not be a qualified expense. For more details, see IRS Form 970 (PDF).
Don't Miss Out on Tax Credits
You may be eligible for one of the educational tax credits, the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit, which give you a tax break on college expenses. But if you use your 529 plan for those expenses, you won’t qualify for a credit.
“The IRS doesn’t allow double dipping,” says financial aid expert Mark Kantrowitz, former publisher of savingforcollege.com.
So plan ahead to avoid disqualifying for a tax credit. Kantrowitz recommends paying up the credit limit on tuition and textbook expenses before using a 529 plan distribution to pay the remaining costs.
With the AOTC, you get a $2,500 tax credit per eligible student when you spend $4,000 on qualified college costs. It’s available for the first four years of college. Eligibility for the tax credit begins to phase out for single taxpayers with incomes above $80,000, and it cuts off at $90,000. For parents who are married and filing jointly, the credit begins to phase out if they have an income of at least $160,000. There’s no credit if the couple’s income is $180,000 or more.
The Lifetime Learning Credit gives you up to $2,000 a year per return, and it can be applied to undergraduate, graduate, and professional degree courses. There is no limit on the number of years you can claim the credit. The income limits were recently adjusted to match the AOTC.
Spend or Save Leftover Funds
If you’re among the few savers who end up with a balance upon your child’s college graduation, you have a few options.
You can save the money for graduate school or switch the beneficiary to another family member, such as a younger child, or a spouse who’d like to go back to school.
You can also cash out of the account entirely. If you do that, you’ll owe interest on the earnings only, plus you’ll pay a 10 percent penalty.
