A 529 qualified expense is a government-approved reason to take money out of a 529 college savings plan – meaning you won’t have to pay a tax penalty. While tuition is the main qualified expense you think of when you get a 529, there are other tangential education expenses that will also apply. There are many, but it is important that you know exactly which expenses are qualified so you aren’t surprised by any penalties. For help with 529 plans or any other financial issues, consider working with a financial advisor.
529 Plan Qualified Expenses Defined
Your 529 plan funds can pay for qualified higher education expenses penalty free. But take your money out of the plan for any other reason, and Uncle Sam may come for a cut.
Still, the federal government has a wide range of what it considers 529 plan qualified expenses. Luckily, they include some of the priciest college costs out there. Below, we lay out what counts.
- Tuition: Your savings can tackle tuition at any eligible institution. That means any college participating in a financial aid program that the U.S. Department of Education runs. That includes community colleges, universities, trade schools and graduate institutions across the country. Even tuition at some foreign schools can count as qualified 529 plan expenses. You can look up which schools are eligible on the website for the Free Application for Federal Student Aid (FAFSA). You can also contact a school’s financial aid office to verify.
- School Supplies: Your 529 plan funds can pay for books, school supplies and items required for enrollment. Your student’s syllabi typically lists these items.
- Tech: Computers, printers, software, electronic equipment and even internet access for which your beneficiary is the primary user make the cut if they are necessary for enrollment.
- Special Needs Resources: Your plan covers special equipment your student needs to enroll and attend college if he or she has a particular disability.
- Room and Board: Your 529 plan covers room and board paid directly to the school for a student enrolled at least half time. Off-campus housing gets deemed a qualified expense too, as long as the cost doesn’t exceed the estimated price of on-campus or off-campus housing published by the school. You can find these details through the school’s financial aid office or on the college’s website. However, the IRS would treat any amount exceeding those numbers as a nonqualifed expense.
With that said, it’s very important to note that any withdrawals you make in a given academic year can’t exceed your adjusted qualified higher education expenses (QHEE). The school’s financial aid office often calculates this for you. But you can figure it out. Just deduct the price of the qualified 529 expenses mentioned above from untaxed educational aid. This includes grants, tax-free scholarships and federal or employer-assistance programs. You’d also have to subtract the amount of any American Opportunity Tax Credit or Lifetime Learning Credit you claim. The IRS won’t let you double dip.
529 Plan Qualified Expenses: What Doesn’t Count
Your 529 plan can’t cover all educational expenses without penalty. Observe some examples below.
- Transportation Costs: Going to college and coming back home can be expensive. But these costs are unfortunately not 529 plan qualified expenses. So you may want to consider economy transportation for your college kid.
- Student Loan Expenses: As burdensome as student loans are to the average grad, they are not 529 plan qualified expenses.
- Insurance and Medical Expenses: Even if the school offers it, health insurance bills don’t count as 529 plan qualified expenses.
- Fitness Club Memberships: Several schools offer students gym memberships. But you’ll have to do the heavy lifting with your own money. Uncle Sam won’t spot you by counting these costs as 529 plan qualified expenses.
- Expenses Associated with School-Sponsored Clubs: Your student should engage in extracurricular activities. Unfortunately, any related fees aren’t 529 plan qualified expenses.
529 Plan Withdrawal Rules
So now know what counts as a qualified 529 plan expense and what doesn’t. You’re ready to make a withdrawal and send your kid off to college. Not so fast. It’s easy to make withdrawals with the click of a mouse. But you don’t want to trigger a tax penalty unwittingly.
Contact the financial aid office and determine exactly how much you need for the academic year. Ask what counts as a qualified 529 plan expense. And to what extent. You can also find a financial advisor to help you make withdrawals with peace of mind.
Also be sure to keep a nice digital or paper trail of your 529 plan activity. Your plan managers typically provide such documents. But you’re responsible for reporting your withdrawals and expenses to the IRS. So come tax time, you’ll need this information to fill out your form 1099-Q.
What Happens If You Pay for Nonqualified Expenses?
You should know what you’re up against if you’re considering a nonqualified withdrawal. First, the earnings portion of your nonqualified withdrawal would face federal income tax at your bracket plus a 10% penalty.
What exactly is the earnings portion? Well, it depends on what part of your 529 account balance was made up of earnings or what you got in the market from investment returns when you made the nonqualified withdrawal.
So say you contributed $14,000 toward your 529 plan and it grew to $20,000 in five years. In this case, 70% of that balance equals your contributions and the remaining 30% is what you earned in the market.
Next, you make a nonqualified withdrawal worth $10,000. The earnings portion (30%) or $3,000 would face federal income tax at your bracket plus a 10% penalty. So if you’re in the 24% tax bracket, you’ll owe a 34% tax on that portion.
And that’s just at the federal level. It’s possible you’ll also owe state income tax on the earnings portion of your withdrawal. You might also have to pay back income tax deductions you claimed on your contributions.
You should speak to a tax professional or financial advisor about the real tax hit you’ll take for making a nonqualified withdrawal based on your individual situation. Or better yet, consult an advisor to find alternatives to tapping into your child’s college fund if you’re really considering it.
After years of saving, you’ll want to make the most out of what you’ve worked hard to sock away.
529 college savings plans offer the most bang for your buck when used the right way on 529 plan qualified expenses. So keep in mind what counts and what doesn’t. Be sure to keep the financial aid office phone number close — and your financial advisor’s number closer.
Tips for Identifying 529 Plan Qualifying Expenses
- A financial advisor can help you identify 529 plan qualifying expenses. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
- Remember to keep records of all your 529 plan activity including contributions and withdrawals. You’ll have to report this to the IRS come tax time. For your convenience, we’ve reviewed the best tax software out there to highlight the benefits that would shine for different types of taxpayers.
Photo credit: ©iStock.com/noipornpan, ©iStock.com/RichVintage, ©iStock.com/fstop123.