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Can I avoid the 529 plan withdrawal penalty?

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A 529 plan is an investment account that you can use to save for a child’s college education, or even your own. Earning tax-free growth on your investments and possibly getting a tax deduction or credit on your contributions are big reasons why the education savings plan is so appealing.

But one feature that causes some to think twice about using one is the 529 withdrawal penalty. Although there are some 529 withdrawal penalty exceptions, using your college savings plan funds for ineligible expenses can be costly.

529 plan withdrawal rules

Because a 529 plan offers tax breaks for education savings, the IRS has some strict rules on how you can use the funds without incurring a penalty.

More specifically, if you want to avoid taxes and a penalty for withdrawing from a 529 plan for your college-aged student, you can use the money to cover only the following:

  • Tuition and fees.
  • Textbooks.
  • Supplies.
  • Equipment.
  • Room and board, if you’re attending at least half time and pursuing a degree or certificate program.
  • Computer and internet access.
  • Equipment for a student with special needs.

Account holders can also use 529 plan funds to pay up to $10,000 per year in K-12 tuition expenses. You can typically make withdrawals from the account through your plan’s provider either online, by phone or by mail.

What is the 529 plan withdrawal penalty?

If you don’t use your college savings plan for eligible expenses, your 529 plan nonqualified withdrawals may incur a 10 percent penalty and will also be subject to income taxes.

That said, both the penalty and the taxes apply only to your gains in the account. This is because the money you contributed was already taxed, so you’re getting tax-free growth only on what your investment earns.

For example, let’s say you’ve contributed $15,000 to the plan and you’ve earned $10,000 in gains, for a total balance of $25,000. If you take a distribution of $5,000 for nonqualified expenses, you’d only have to pay the penalty and taxes on $2,000 of that, because it’s the portion of the withdrawal that’s attributable to your gains.

It’s important to note that there’s no 529 early withdrawal penalty like there is with retirement accounts, because you can use your plan funds for eligible K-12 and higher education expenses.

Exceptions to the 529 withdrawal penalty

In general, you can’t escape income taxes on 529 plan nonqualified withdrawals. But there are some exceptions to the 10 percent penalty:

  • The beneficiary of the plan has died or become disabled.
  • The beneficiary received a tax-free scholarship.
  • The beneficiary received educational assistance through a qualifying employer program.
  • The beneficiary is attending a U.S. military academy.
  • The funds are used to claim another educational tax benefit, such as the American opportunity tax credit, lifetime learning credit or tuition and fees deduction.

When it comes to scholarships, educational assistance and military academy attendance, you can withdraw up to the amount of the benefit you or your child received and avoid the penalty. If you withdraw more than that amount, the excess will be penalized.

It’s also important to note that some states may have different rules than the federal government. For example, your state may consider withdrawals for K-12 tuition expenses to be a nonqualified distribution. Your state may also reverse past deductions or credits that you received for contributions if you don’t use your 529 plans for qualified expenses or if you transfer the money to another state’s plan.

As a result, it’s a good idea to consult a tax professional before you consider taking money from your 529 plan.

Ways to use a 529 plan outside of paying for your child’s college expenses

If your child decides not to attend college or gets enough assistance through scholarships or an employer that they don’t need the money you’ve saved, don’t fret. There are other ways to still enjoy the benefits of tax-free withdrawals.

Help a family member pay for school

As the owner of the 529 plan, you’re allowed to change the beneficiary to someone else in your family. So if one child doesn’t need the funds, you can switch your beneficiary to another child or even another family member of the original beneficiary.

Pay down student loan debt

In 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. The bill allows 529 plan owners to use up to $10,000 to pay off student loan debt for their child without any tax consequences or penalty. The limit is based on the beneficiary, not the account, so you can use this approach with more than one beneficiary.

Pay for K-12 education

As previously mentioned, 529 plan owners can also use funds to pay up to $10,000 per year in K-12 tuition expenses without any penalty or tax burden. This can be especially helpful if you have children in private schools.

Pay for training program expenses that qualify

529 plan withdrawals don’t incur taxes or fees as long as your child is attending an eligible postsecondary institution, which includes trade schools. If there’s another type of training program that your child wants to pursue, check the IRS’ list of eligible educational institutions to see if you’re in the clear.

Pay for your own education

In addition to changing the beneficiary from child to child, you can also change it to yourself. If you plan to pursue a postsecondary degree or certificate of your own, you can use leftover 529 plan funds to cover your expenses without incurring a 529 withdrawal penalty.

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Written by
Ben Luthi
Contributing writer
Ben Luthi is a personal finance and travel writer who loves helping people learn how to live life more fully. His work has appeared in several publications, including U.S. News & World Report, USA Today, Yahoo! Finance and more.
Edited by
Student loans editor