529 Plans and Taxes: Deductions, Tax-Free Withdrawals & More
Are 529 plan contributions tax deductible? Not on your federal tax return, but maybe on your state return. However, other federal tax savings are available for people using 529 plans to save for college or other education costs.
Key Takeaways
- Although contributions to 529 plans are not tax-deductible at the federal level, many states offer tax deductions or credits for contributions.
- Contributions to a 529 plan grow tax-free and can be withdrawn tax-free if used for qualified education expenses. Taxes and penalties may apply if 529 funds are used for nonqualified expenses, such as for transportation, health insurance, and extracurricular activities.
- Qualified college expenses for tax-free withdrawals from a 529 plan include tuition, fees, books, room and board, computers, and more.
- If you have unused funds in a 529 plan, you can leaving the money in the account for future educational expenses, pay off student loans (up to $10,000), transfer funds to a Roth IRA (up to $35,000), or roll over the money to another family member’s 529 or ABLE account.
What is a 529 plan?
Millions of Americans use 529 plans to save for college or other education expenses for a child or other designated beneficiary. In most cases, they’re used by parents to save for their own child’s education. But you can open a 529 plan account for anyone – even for yourself.
There are two different types of 529 plans: education savings plans and prepaid tuition plans. With an education savings plan, you open an investment account to save for the beneficiary’s future education expenses. On the other hand, with a prepaid tuition plan, you pay college expenses at current prices, even if the beneficiary won’t attend college until years later. The savings plans are more popular than prepaid plans, so we’ll focus on them in the discussion below.
Most 529 plans are set up and managed by states (although educational institutions can also sponsor a prepaid 529 plan). But if you want to open a 529 account, you don’t necessarily have to do it with your state’s 529 plan. You’re free to shop around.
There are many reasons why 529 plans are so popular – it’s generally easy to open and manage an account, funds can be used to pay for a variety of educational expenses, there are no income restrictions for contributing to a 529 plan, and more. But the tax advantages that 529 plans offer are probably the biggest draw.
Let’s explore those tax benefits in more detail.
TurboTax Tip:
A 529 plan account is set up to save for a beneficiary’s educational expenses. There can only be one beneficiary per 529 account, but a single person can be the beneficiary for multiple accounts.
Are 529 plan contributions tax deductible?
When you hear that there are tax benefits for 529 plans, you might assume that contributions to 529 plans are tax deductible. But whether that’s true depends on if you’re talking about a tax deduction for your federal or state income taxes.
There’s no federal tax deduction for contributions to a 529 plan. As we’ll discuss shortly, there are other federal benefits available for these tax-advantaged accounts. But there are no federal tax breaks when you contribute to a 529 account.
However, most states offer either a tax deduction or credit for contributions to 529 plans (but not for states without an income tax). How much of a tax break you can get varies by state and can range from a few hundred dollars to several thousand dollars.
There are often limitations and restrictions on these state tax breaks, though. For instance, you might have to contribute to the 529 plan sponsored by your state to qualify for the deduction or credit. You also might not be able to deduct or claim a credit for all your 529 plan contributions each year, since these state tax breaks tend to be capped.
Check with the state tax agency where you live to see if your state offers any tax breaks when you put money into a 529 account.
Tax-free growth and withdrawals from 529 plans
So what federal tax breaks are available for 529 plans?
First, money in a 529 account grows tax-free. As a result, you don’t have to pay income tax each year on any earnings. In contrast, if you put money in a regular savings account instead of in a 529 plan, you’ll have to pay tax every year on the interest earned on that account.
Second, you can also take money out of a 529 plan without paying tax as long as the funds are used for qualified education expenses (more on qualified expenses in a minute). When compared to a regular investment account – where you have to pay capital gains tax when you sell stock or other assets held in the account – this can save a lot of money.
Qualified vs. nonqualified expenses for 529 plans
Generally, you don’t have to pay federal income tax on money taken out of a 529 plan if it’s used to cover the beneficiary’s qualified education expenses.
But what are qualified education expenses? They generally include any costs required for the enrollment or attendance at a college, university, vocational school, or other postsecondary educational institution that’s eligible to participate in a federal student aid program administered by the U.S. Department of Education. This can include public or private colleges, community colleges, graduate schools, trade schools, and more.
As for specific costs at these schools, you can generally use 529 plan funds to pay for:
- tuition, fees, books, supplies, and equipment required for enrollment or attendance
- room and board for a student who’s enrolled on at least a half-time basis
- special needs services, such as tutoring, counseling, service animals, and the like
- computers (and peripheral equipment), software, and internet access
But you can use funds from a 529 account for more than just college and other postsecondary education expenses. There’s no federal income tax on 529 plan withdrawals used for:
- tuition at an elementary, middle, or high school (up to $10,000 per year)
- student loan payments (up to $10,000 per beneficiary)
- apprenticeship program fees, books, supplies, and equipment
On the other hand, there are plenty of school-related expenses that aren’t qualified expenses for 529 plan purposes. For instance, common nonqualified expenses include cost for:
- transportation to and from school
- extracurricular activities
- health insurance for students
- college application fees
- SAT or ACT preparation courses
- software designed for sports, games, or hobbies (unless it’s predominantly educational in nature)
A student’s other ordinary personal expenses – such as for clothes, phones, entertainment, and the like – don’t count as qualified education expenses, either.
Taxes and penalties if you use 529 plan funds for nonqualified expenses
The tax breaks for 529 plans help you save for college or other education costs. But if you use 529 plan funds for other purposes, some of those tax breaks go away. You might also have to pay an additional penalty.
For example, if the amount withdrawn from a 529 plan during the year is greater than the beneficiary's qualified education expenses for that year, a portion of the withdrawn earnings may be subject to federal income tax. However, there’s no tax on any contributions withdrawn from the account.
In addition, you might owe a 10% penalty on the taxable amount (assuming the penalty isn’t waived as described below). If you received taxable funds from a 529 plan, use Form 5329 to calculate the penalty, which is then reported on Line 8 of Schedule 2 (Form 1040).
Who pays the tax?
Whoever receives 529 funds that aren’t used for qualified education expenses is responsible for paying any tax on earnings. That can be the person who opened the account or the beneficiary.
If a 529 plan withdrawal is sent directly to the beneficiary’s school, it’s treated as if the beneficiary received the funds for income tax purposes.
How do you calculate and report taxable earnings?
There’s a four-step process for determining the taxable earnings (if any) to report on your return when 529 plan funds you received during the tax year are used for nonqualified expenses. This amount is reported as “other income” on Schedule 1 (Form 1040). If all of the money you received from 529 plans was used for qualified expenses, then you don’t have to report anything on your tax return.
Step 1 – Determine the beneficiary’s “adjusted qualified education expenses” (AQEE). Basically, the beneficiary’s AQEE is the total amount of qualified education expenses for the year, minus any tax-free educational assistance and any education expenses used to claim the American Opportunity Tax Credit or the Lifetime Learning Credit. Tax-free educational assistance includes:
- tax-free part of scholarships and fellowship grants
- veterans' educational assistance
- tax-free part of Pell grants
- employer-provided educational assistance
- any other tax-free payments (other than gifts or inheritances) received as educational assistance
You can stop here if the total amount distributed during the year from 529 plans opened for the beneficiary is less than or equal to the beneficiary’s AQEE. If that’s the case, none of the withdrawn earnings are taxed.
(Note: If you receive money from both a 529 account and a Coverdell education savings account (ESA) in the same year, and the total of these withdrawals is more than the beneficiary’s AQEE, you have to allocate part of the AQEE to the Coverdell ESA withdrawal. This will reduce the AQEE for purposes of calculating any taxable earnings from your 529 account distributions. See IRS Publication 970 for more information.)
Step 2 – Determine the total earnings withdrawn. You should receive a Form 1099-Q if money is taken out of a 529 plan during the year (more on this form later). Box 2 of Form 1099-Q shows the portion of the amount paid to you from the 529 account that represents earnings. If you withdrew money from more than one 529 account during the year, add up the amount in Box 2 for all the 1099-Q forms you receive. This is your total withdrawn earnings.
Step 3 – Calculate your tax-free earnings. For this step, divide the AQEE by the total amount you received from 529 plans during the year. Then multiply the resulting amount by your total withdrawn earnings from Step 2. This will tell you how much of the withdrawn earnings are not taxed.
Step 4 – Calculate your taxable earnings. Subtract your tax-free earnings from Step 3 from your total withdrawn earnings from Step 2. The result is the amount you must include in taxable income on your tax return, which is reported as “other income” on Schedule 1.
Here’s an example:
Your parents opened a 529 account for you when you were a baby (you’re the beneficiary). They put a total of $15,000 in your account over the years, but it has grown in value to $25,000.
As you head off to college, you withdraw $15,000 from the 529 account. The Form 1099-Q indicates that $2,000 of that amount is earnings. Your parents also kick in an additional $4,000 to help with tuition and books, which they use to claim the American Opportunity Tax Credit. In addition, you pull $3,500 from your own savings account, and you receive a tax-free scholarship for $2,500. All $25,000 ($15,000 + $4,000 + $3,500 + $2,500 = $20,000) is used for college-related costs, but only $19,000 is used to pay for qualified education expenses.
In this case, your AQEE is $12,500. This is determined by subtracting the $2,500 tax-free scholarship and the $4,000 of expenses used by your parents to claim the American Opportunity Tax Credit from the $19,000 of qualified education expenses ($19,000 - $2,500 - $4,000 = $12,500). Since your AQEE ($12,500) is less than the amount withdrawn from your 529 account ($15,000), part of the earnings is taxable.
The tax-free earnings equal $1,666. To get this amount, you first divide your AQEE ($12,500) by the amount withdrawn from your 529 account ($15,000), which comes to 0.833. You then multiply that figure by your total withdrawn earnings ($2,000), which equals $1,666.
That means you have $334 in taxable earnings ($2,000 - $1,666 = $334), which you have to report as “other income” on your Schedule 1.
Waiver of 10% penalty
The 10% penalty is applied to any taxable earnings. So, in the example above, you would owe additional $33.40 in penalties ($334 x 0.10 = $33.40).
But there are some situations where the IRS will waive the penalty. For instance, the penalty generally won’t be applied if the beneficiary dies or becomes disabled.
If the beneficiary attends a U.S. military academy (such as West Point or the Naval Academy), the penalty can also be waived.
The 10% penalty can also be avoided if earnings are included in taxable income because either the:
- beneficiary receives tax-free scholarship or other educational assistance (other than a Pell grant)
- qualified education expenses are used to claim the American Opportunity tax credit or Lifetime Learning Credit
Gift taxes on 529 plan contributions
For the most part, only the very wealthy need to worry about the federal gift tax. But if you fall into that category, you should be aware that contributions to a 529 plan are considered “gifts” to the beneficiary for gift tax purposes.
As a result, if the total of your contributions and other gifts to a single beneficiary during the year are greater than that year’s gift tax exclusion ($18,000 for 2024 and $19,000 for 2025), you must report the excess amount to the IRS by preparing a gift tax return using Form 709. Depending on how much you’ve reported to the IRS over the years, you might have to pay gift tax on the contributions, too.
However, there’s a special rule that lets you “superfund” a 529 account by contributing more than the gift tax exclusion amount in a single year. Under the rule, you can contribute up to five year’s worth of contributions to a single beneficiary’s 529 account in one year. So, for example, you can contribute up to $95,000 ($19,000 x 5 = $95,000) to a beneficiary’s account in 2025. If you’re married, your spouse can also contribute the same amount to the account – for a total of $190,000 in 2025 ($95,000 x 2 = $190,000).
You generally have to report an equal portion of the contribution (20%) on Form 709 over a five-year period (although you don’t have to report the 20% amount for any of the last four years if you’re otherwise not required to file Form 709 for that year). However, you won’t have to pay gift tax on it. As a result, superfunding can be both a fast and tax-friendly way to fund a 529 plan account. But if you contribute more to the account during the five-year period, you might have to report the additional gift and pay tax on it.
What if you have leftover funds in a 529 plan?
Suppose you diligently stuffed money in 529 plans for your children since they were little. But when they graduate high school, they decide against going to college, get a full scholarship, attend a low-cost college, or don’t need all the money you saved for some other reason.
As a result, there’s money in their 529 accounts that isn’t going to be used for education expenses (at least not now). What can you do with it?
You can always take it out of the 529 plan and use it for everyday expenses or blow it on a fancy vacation. But that means you’ll have to pay taxes and penalties on the earnings, which you might not want to do.
Fortunately, there are several options that won’t increase your tax bill (at least not yet) if you have unused funds in a 529 account.
- Leave the money in the account for now. Money in a 529 plan can be used for the beneficiary’s education costs at any time. So, if you don’t have any qualified expenses now, you can simply wait to see if you have any later.
For instance, if money is leftover after receiving an undergraduate degree, the extra funds could be used down the road for grad school. And a child that doesn’t attend college right out of high school might decide to go later.
At some point, you can withdraw the funds and pay the tax and penalty due if it doesn’t look like the beneficiary will need the money for education costs. But there’s no harm in kicking the can down the road until you reach that point.
- Pay off student loans. As noted earlier, up to $10,000 of student loan debt counts as a qualified education expense. So, for example, if the beneficiary has unused funds in a 529 plan, up to $10,000 of the leftover money can be put toward their student loan debt. It can also be used to pay up to $10,000 of their sibling’s student loans.
However, don’t forget that the $10,000 limit is per beneficiary, not per year. That also means that 529 plan funds used to pay a sibling’s student loan debt counts toward the sibling’s $10,000 cap, not against the beneficiary’s limit.
In addition, if the beneficiary (or sibling) claims the student loan interest deduction, the deduction is reduced by any tax-free earnings from a 529 account used to pay their student loan.
- Transfer the money to a Roth IRA. Up to $35,000 can be rolled over from a 529 plan to the beneficiary’s Roth IRA. But there are certain restrictions on this type of transfer. For instance, the 529 account must be opened for at least 15 years, and the money has to be sent directly from the 529 account to the Roth IRA (you can’t receive it in between).
You also can’t transfer more than the amount contributed to the 529 plan up to the date that is five years before the transfer, plus earnings attributed to those contributions. So, for example, if you want to move money from a 529 plan to the beneficiary's Roth IRA on December 1, 2025, you can’t transfer more than the amount contributed up to December 1, 2020, plus attributed earnings (the transfer also can’t exceed $35,000).
In addition, the amount transferred, plus any other IRA contributions to the beneficiary’s IRAs, can’t be more than the IRA contribution limit for that year. For the 2025 tax year, the IRA contribution limit is $7,000 ($8,000 if you’re at least 50 years old).
- Transfer the money to a family member’s 529 account. Unused funds in a 529 account can also be transferred to a family member’s 529 account without having to pay taxes or penalties. There are two ways to do this. You can withdraw the leftover money and deposit it in the family member’s account within 60 days, or change the account beneficiary to the family member.
The family member has to be the beneficiary’s:
- spouse
- child (including a stepchild, foster child, or adopted child), or a descendant of a child
- sibling (including a stepbrother or stepsister)
- parent, or ancestor of a parent
- stepfather or stepmother
- niece or nephew
- aunt or uncle
- son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
- the spouse of any relative listed above
- first cousin
Once the money is transferred, all the normal tax rules apply to the new beneficiary. So, for example, taxes and penalties will apply if the funds aren’t used for the family member’s qualified education expenses.
- Transfer the money to a family member’s ABLE account. You can also transfer money from a 529 account to a family member’s Achieving a Better Life Experience (ABLE) account, which is a tax-advantaged savings account for people with disabilities.
You can only put so much money in an ABLE account each year (up to $19,000 in 2025). Transfers from a 529 plan count against the annual contribution limit, so make sure you don’t exceed the limit if you’re rolling over unused 529 funds into an ABLE account.
How are 529 plan withdrawals reported to you (Form 1099-Q)?
When money is taken out of a 529 account, the plan administrator will send Form 1099-Q to the person who received the distribution and to the IRS. That can be the person who opened the account or the beneficiary. If the money was sent directly to the beneficiary’s school, Form 1099-Q will be sent to the beneficiary.
Among other things, the form will show the total amount you withdrew from the 529 account during the tax year (Box 1), how much of the amount withdrawn is allocated to earnings (Box 2), and how much of the amount withdrawn is allocated to contributions to the account (Box 3).
You should receive any 1099-Q forms for the tax year by January 31 of the following year. For example, 1099-Q forms for the 2024 tax year are due by January 31, 2025. If January 31 falls on a weekend or holiday, then you should have your form(s) by the next business day.
How to open and contribute to a 529 plan
It’s easy to open a 529 account for a child, grandchild, or anyone else. In most cases, you can open an account through the plan’s website. This is usually the fastest and easiest method. But if you prefer, you can often download a paper application from the plan’s website and mail it in.
You also might have to put some money in the account when you open it. However, for 529 plans that require a minimum initial contribution, the amount you have to deposit to open an account is typically pretty low.
You’ll also have to choose an investment option. Most 529 plans offer a few options, such as age-based portfolios or individual fund options. Pick the one that aligns best with your risk tolerance and investment goals.
Once the account is open, it helps to make regular contributions if you can. You might be able to set up automatic deposits directly from your bank account into a 529 account. Your employer might also allow payroll deductions to help you fund the account (some companies will even make their own contributions to their workers’ 529 accounts).
There’s no annual or total contribution limits for 529 plans under federal law, although taxes and penalties may be due if total contributions exceed the beneficiary’s expected qualified education expenses (see above). However, all state-sponsored 529 plans set a maximum balance per beneficiary (typically between $500,000 and $600,000). So, if your account balance reaches the maximum amount, you won’t be able to contribute more to the account.
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