What Your 529 Savings Plan Means for Your Taxes

If you’re planning on utilizing a 529 Savings Plan for college expenses, it’s important to understand its tax implications. Will you owe taxes on the money your parents saved for your college (or private primary school) tuition? How can you spend the money? We answer these questions and more in this article.  

What is a 529 savings plan?    

A 529 savings plan is a way to save for college that offers tax and financial benefits. 529 savings plans may also be used to save for K-12 tuition. This investment account allows you to grow the account tax-free and withdraw funds tax-free when used for qualified education expenses.  

There are two main types of 529 savings plans:   

College savings plans – These work a lot like a Roth 401(k) or Roth IRA. The taxpayer invests their after-tax contributions in mutual funds or similar investments. The account will fluctuate in value based on the investment options’ performance.   

Prepaid tuition plans – These allow the parent or guardian to prepay a portion of the costs of an in-state public college education. If you, the college student, decide that you want to attend a private or out-of-state college, the plan can be converted.  

Read also: What is the Better College Savings Plan: The 529 or the Roth IRA?  

How can I use my 529 savings plan?    

There are three main types of expenses you can pay with these funds.  

Qualified education expenses  

These include tuition, fees, books, supplies, equipment, computers, and sometimes room and board (for students enrolled at least half-time) at most college institutions. Transportation and health insurance are not considered qualified expenses.   

Federal and private student loans  

The SECURE Act of 2019 allows tax-free distributions from a 529 savings plan for repaying student loans up to $10,000 per borrower (lifetime limit).  

Private, public, and religious K-12 expenses  

You can withdraw up to $10,000 tax-free per year, per beneficiary, to pay for tuition expenses at most K-12 schools per the Tax Cuts and Jobs Act.  

How do I use my 529 plan?   

Most plans allow you to distribute payments directly to the account holder (your parent or guardian), the beneficiary (you, the college or K-12 student), or the school. Some plans may even allow you to make a payment directly from your 529 account to another third party, such as a landlord. Plans vary, so check with your individual plan to make sure you know the withdrawal limits and terms.   

Read also: 529 Withdrawal Mistakes to Avoid 

What expenses are not covered by a 529 savings plan?    

Expenses required for enrollment at an eligible college or institution are covered. However, there are some costs, like gas money or public transportation, that you may need, but the IRS does not consider a qualified expense. For example, health insurance is not a qualified expense, unless the college charges it as part of the total tuition fee, or the fee is flagged as a required fee.  

You can technically withdraw funds for any reason. However, the earnings portion of a non-qualified distribution will usually be subject to income taxes and a 10% tax penalty. If you withdraw a non-qualified distribution, be aware you will pay the penalty.  

Are 529 plan contributions tax-deductible?    

Contributions to a 529 plan are made post-tax and are not deductible from your or your parent’s federal income taxes. However, many states offer state income tax deductions or tax credits for contributions to 529 plans in that specific state. It is worth noting that you may need to report contributions to or withdrawals from your 529 plan on your annual tax returns.  

Funds in a 529 plan grow federal tax-free. They will not be taxed when the money is withdrawn for qualified education expenses.   

What happens to the money not used in a 529 plan? 

If you decide not to attend college or don’t need the money to pay for your education, your parents or guardians won’t lose the money they saved in the 529 savings plan. They will generally pay income tax and a penalty on the earnings portion of a non-qualified withdrawal, but there are some exceptions. The penalty is waived if:    

  • You receive a tax-free scholarship    
  • You attend a U.S. Military Academy    
  • The beneficiary dies or becomes disabled    

If you or your guardians want to avoid paying fees on the earnings, there are a few options, including:    

  • Making another member of the family the beneficiary   
  • Make the parent or guardian the beneficiary and further their education    
  • Take up to $10,000 in tax-free withdrawals for K-12 tuition    
  • Repay up to $10,000 in student loans per borrower for both the beneficiary and the beneficiary’s siblings  
  • Save the funds in the account in case you want to attend grad school or college later    
  • Roll over the funds to a 529 ABLE account  

This article is intended to provide general information to the public and does not provide personalized tax, investment, legal, or business advice. You should seek the assistance of a professional for advice on taxes, investments, and any other financial, legal, or business matter pertinent to your individual situation.