It’s the season for applicants to receive college admission letters and financial aid packages. The long speculation about the impending cost of college, once an abstract financial goal for families, is now a very real looming expense.
The cost of college is often the most overwhelming concern for students and parents planning for education. For some families, it’s just an extension of a long-running concern about tuition and fees for private or religious K-12 schools. To help Americans cover these costs, Section 529 of the Tax Code authorizes tax-advantaged savings plans officially called Qualified Tuition Programs (almost universally called 529 plans) to help with education costs.
The benefit of following the rules for 529 plans can be substantial. Qualified distributions (withdrawals) from 529 plans are exempt from federal tax (and usually state tax as well). But non-qualified distributions are not only taxed on your federal return but, in many cases, are subject to a 10% penalty as well. So it pays to know the rules for what counts as a qualified distribution, including eligible educational institutions, relationship to financial aid awards, and more.
You are required to report all 529 plan distributions to the IRS on your tax return, so it’s critical to keep detailed records of qualified and non-qualified expenses.
Here are some details on qualified educational expenses to get the tax advantage from your 529 plan.
It would be natural to imagine that your 529 plan distributions can be equal to your qualified expenses for an academic year. But remember, tax returns are based on the calendar year. Be sure to take your 529 plan distributions during the same calendar year as the expenses. If you inadvertently follow the academic year, you may owe taxes on a non-qualified portion of your withdrawal.
Tuition and fees from these institutions will qualify for 529 plan distributions.
- College or graduate school: Post-secondary students are eligible to participate in the federal student aid program administered by the U.S Department of Education and qualify for the use of 529 plan funds. Funds can be used for four- and two-year colleges, trade schools, graduate programs, and some international institutions.
- Vocational and trade school: Students at trade schools (e.g., culinary, cosmetology, or automotive schools) can use 529 plans to pay for expenses related to their courses. The institution must participate in the U.S Department of Education’s program for federal student aid.
- Primary and secondary education: K-12 schools, whether public, private, or religious, are now eligible institutions for the use of 529 plan distributions up to $10,000 per student per year, but for tuition only (not for other fees). It is important to note that some states tax or penalize these distributions.
Lifestyle and Supplies
Sit down with family members and the future student to create a withdrawal plan that works for the student’s needs, keeping in mind that not all college costs are qualified purchases.
- Campus housing can be paid through 529 plan distributions, including college room and board fees. Off-campus housing rentals qualify up to the same cost of the room and board on campus.
- Books and supplies, including paper, pens, textbooks required by the specific course, are all qualified expenses, but in an amount determined by each college for each academic year.
- Equipment and services for those with special needs also qualify for 529 plan distributions. Students using equipment for mobility or assistive technology (such as screen readers) may be eligible for 529 plan distribution purchases. Depending on the circumstances, transportation may also apply. Some of these expenses may also qualify for other tax benefits, so consult your tax advisor to create the strategy that provides the best tax advantage for these expenses.1
Computers and some electronics can sometimes be qualified education expenses for 529 plan distributions. They must be required as part of the student’s program of study.
- Computers must be used primarily by the student during any of the years they are enrolled at the eligible educational institution.
- Some software qualifies for 529 plan distributions. For example, technical engineering or design classes may involve computerized assignments requiring special software.
- Internet services can be paid using 529 plan funds.
Notably, cell phones and plans are not qualified expenses.
There may also be specialized onboarding expenses for new students or required costs as they complete their courses of study that may qualify.
Section 529 plans should only be one part of your college planning strategy. Your tax advisor can help you decide how best to approach college expenses to optimize the tax benefits you receive. We recommend a multi-year strategy that considers your student’s plans and the effects that distributions from 529 plans could have on future financial aid.2
Keep in mind, individual states and schools may influence how you can use funds from a 529 plan. Check with your financial advisor or plan provider to develop the best strategy for your 529 plan distributions so you can optimize your finances while reaching your educational goals.
1. You may also want to check out our article on ABLE accounts, a similar type of plan specifically for people with expenses related to a disability.
2. Financial aid impacts are usually small for 529 plan distributions from accounts owned by the student or their parent. Distributions from an account owned by someone else—for example, a grandparent—can significantly affect financial aid.