How to make a withdrawal from your 529 plan

Education

Posted on August 8th, 2024

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The college acceptance letters have come in, your child is excitedly picking out their majors and minors, you're planning to turn their room into a greenhouse for all your plant babies... it's an exciting time. With the help of your family and friends, you managed to save enough in your 529 plan to cover just about everything your child could need, but how the heck do you make a withdrawal?

529 withdrawals are tax free when used on unlimited qualified educational expenses, up to $10,000 per year on K-12 tuition, or up to $10,000 of student loan repayment. It's not difficult to make withdrawals from your plan, but there are a few steps to follow to make sure you're reaping all the benefits.

Start a 529 college savings plan

1. Timing is everything

It's important to withdraw the funds in the same tax year that they'll be used. So don't withdraw a full school year's worth of funds from your 529 at the beginning of the school year in the fall. Figure out which expenses need to be paid in the current tax year, and only withdraw enough to cover those expenses.

2. Calculate your expenses

While you can withdraw any amount of money at any time, it's your money after all, if you're looking to take advantage of tax-free earnings, then you should only withdraw what you need to cover your Adjusted Qualified Educational Expenses (AQEE).

Step 1: Itemize and add up this tax year's qualified educational expenses.

Step 2: Subtract any tax-free assistance you might have (this includes tax-free scholarships, veteran's assistance, and educational assistance through a qualifying employer program).

Step 3: Subtract any expenses used to generate your American Tax Opportunity Credit (AOTC) or Lifetime Learning Tax Credit (LLTC) if you're claiming them.

Using the numbers below as an example, you can see how this person could withdraw $4,000 tax-free:

Step 1: This year's qualified expenses total $10,000

Step 2: Your child won a $2,000 tax-free scholarship

Step 3: You use $4,000 to generate your AOTC

$10,000 - $2,000 - $4,000 = $4,000

3. Submit a withdrawal request

Most plans allow you to submit a withdrawal request online by filling out a simple form. When deciding who to make the withdrawal distribution payable to, the best option would be the beneficiary's college or K-12 school. If it's for something like a laptop, it's always best to make the distribution payable to the beneficiary versus the account owner. Form 1099-Q will then be issued to the beneficiary.

Non-qualified expenses

Sometimes life happens and you need to use the funds for something other than the educational expenses you'd planned for. In this case, you can withdraw any amount at any time, but the earnings portion of your withdrawal will need to be reported on the account owner's or the beneficiary's federal tax returns depending on who the withdrawal distribution was paid to, as these earnings will be subject to income tax, like any other investment, and a 10% penalty. Your original contributions will not be taxed or penalized though. Remember, non-qualified withdrawals paid to a parent will likely be subject to more tax than those payable to the child.

Exceptions to the 10% penalty

529 plans were designed to help parents save effectively for college, the 10% penalty on non-qualified withdrawals is to help deter those who would abuse the system, simply using a 529 plan as a tax-haven with no intent to use them for college expenses.

While the earnings of all non-qualified withdrawals are subject to tax, as with any investment, there are instances where you won't be subject to the 10% penalty. This includes scholarships, attending a U.S. Military Academy, tax-free educational assistance, receipt of education tax credits, the return of excess funds that were previously withdrawn in error, death or disability.

Congrats! Your child's future education is paid for and looking bright! But, how does Uncle Sam know whether you're spending it on qualified expenses or not? Stay tuned, our next blog will cover the important step of reporting 529 plan withdrawals on your tax return.

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