Everything You Need to Know About 529 Plan Withdrawals

Everything You Need to Know About 529 Plan Withdrawals

September 25, 2023

529 plans can be used in every state to pay for education expenses at private K-12 and secondary education institutions such as in-state and out-of-state colleges, universities, and technical colleges. 529 plans are qualified tuition plans that allow state and federal tax-free withdrawals of earnings when used to pay for qualified education expenses.

When it's time to withdraw funds from the 529 plan, you must follow the IRS rules to mitigate penalties. Here is everything you need to know about 529 plan withdrawals:

Decide how much to withdraw- You can take as much money from the 529 plan to cover qualified secondary education expenses without taxes. For K-12 expenses, you should consult your financial and tax professionals because the allowable costs may differ from year to year.

You must take 529 plan distributions during the same year you paid for the qualified expenses because you will need to note this information when you file taxes.

Determine which expenses are qualified. It's essential first to determine which expenses are qualified for tax purposes to avoid the 10% penalty plus taxes on the accumulation. Add up the costs for these items for the calendar year for tax filing and reporting purposes:

  • Tuition and fees
  • Books and supplies
  • Computers
  • Equipment for a class requirement or obtaining a degree

Note that these expenses are not considered qualified:

  • Room and board
  • Transportation
  • Meals

How to avoid tax penalties- 529 plan account owners can withdraw any amount, but only qualified distributions will be tax-free. If you use 529 monies for non-qualified expenses, a 10% penalty will apply to the taxable portion of your withdrawal, plus federal income tax at your tax rate.

Note that the earnings portion of any non-qualified distributions must be reported on the account owner's or the beneficiary's federal income tax return.

Get your 529 plan documentation in order- Form 1099-Q, issued by the 529 plan custodian, will list the amount of the 529 plan distribution. Form 1098-T, issued by the education institution, will detail how much of the 529 plan distribution was used to pay tuition and fees. However, it is up to the 529 plan account owner to calculate the taxable portion when filing taxes. For this reason, 529 plan owners must consult their tax professionals to ensure accurate 529 reporting at tax time.

How to withdraw money- Generally, 529 plan owners can withdraw funds by completing a withdrawal form online on the 529 plan's website. In some instances, they may be able to initiate withdrawals by phone. A third method is manually filling out a withdrawal form and sending it to the 529 plan custodian.

529 plans are an essential way to save for education that may provide tax advantages when used for qualified education expenses. If you have questions about establishing a 529 plan or withdrawing from an existing one, your financial professional can help.

Important Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.

Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing. Non-qualified withdrawals may result in federal income tax and a 10% federal tax penalty on earnings.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This article was prepared by Fresh Finance.

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