An illustration of someone picking up money for article on 529 plans.

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 the funds out.

Withdrawing funds from a 529 isn’t as straightforward as it sounds. And though the amount of money flowing into 529 plans is at record levels—$328 billion (PDF) in 2018, according to the College Savings Plan Network—there’s still a lack of understanding about how the accounts work.

One-third of Americans don’t even know that a 529 plan is a way to save for college, according to a May 2019 survey by financial services firm Edward Jones. And even among those who do, almost half 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. If you’re not careful, 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 start making withdrawals from a 529 college savings account. 

Withdraw Funds Only for Qualified Expenses

You can use funds from a 529 account for a wide range of 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.

More on Paying For College

But 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.

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.

“The 529 provider may not require proof of the withdrawal, but the IRS could have questions,” says Young Boozer, former Alabama state treasurer and current chairman of the National 529 Campaign, a coalition of more than two dozen states working to raise awareness about 529 plans. 

Thanks to a change under the 2017 Tax Cuts and Jobs Act, 529 money can now also be spent on expenses for K-12 education—but only up to $10,000 per student each year. Be aware that 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.

Decide Where You’d Like the Funds to Go

When you’re withdrawing 529 funds, your account provider can pay the school directly or it can write a check to you or your college-age child. Having the money sent directly to the school may sound like the simplest option, but it could have financial aid implications, and it won’t help you if you need the funds to pay for supplies or rent.


Something else to consider is how much control you want to maintain over the funds.

“One of the benefits of a 529 is that the account owner retains control of the assets,” says Brian Boswell, president of 529 Expert, a college financing industry consultant. “Once you’ve disbursed those assets to the beneficiary, you lose that control, and not every student is responsible.”
 

If you have the money sent directly to your college-age child, make sure he or she keeps detailed records and receipts of how the funds are spent.



Remember That Using a 529 Account Can Disqualify You for Tax Credits

The American Opportunity Tax Credit gives you a $2,500 tax credit when you spend $4,000 on qualified college costs. But if you pay for those costs with money from a 529 account, you don’t get the tax credit.

“The IRS doesn’t allow double dipping,” says financial aid expert Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com. “Carve out $4,000 of tuition and textbook expenses before using a 529 plan distribution to pay the remaining costs.”


Additionally, keep in mind that eligibility for the tax credit begins to phase out for single parents with incomes above $80,000. It cuts off at $160,000. For parents who are married and filing jointly, the credit begins to phase out if they have an income of at least $90,000. There’s no credit if the couple’s income is $180,000 or more.

Make Withdrawals Strategically to Minimize Borrowing

It doesn’t always make sense to use all your 529 money at once if you think you will also have to borrow money to pay for school. There are limits to the amount you can borrow via federal loans each year: $5,500 in your student’s first year, $6,500 in the second year, and $7,500 after that if you claim your student as a dependent. 

If you spend your 529 money in the first years of college and need to borrow later, you could exceed federal loan limits and have to turn to costlier, less consumer-friendly private loans, says Fred Amrein, a fee-only financial planner in Wynnewood, Pa., and author of “Financial Aid and Beyond: Secrets to College Affordability.”

Instead, spread out your 529 withdrawals over all four years so that you can keep each year’s borrowing below the federal limits. 

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. 


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