529 Distribution Rules Every Account Owner Should Know

Unpacking 529 Distribution Rules

If you’re saving for your child’s education with a 529 account, you have a solid plan to reach an important goal – one that is realized the day your child begins to withdraw funds to pay for qualified education expenses.

When that time comes, understanding exactly how 529 distributions work will prepare you to make the most of each distribution opportunity. Let’s take a closer look.

529 Plans Explained

You know that 529 plans are excellent savings tools for families looking to expand educational opportunities for their kids or grandkids. In fact, 529 plans allow anyone who wants to support a future learner to make contributions to the account. And as these contributions are adding up, any earnings on those funds are also compounding. Through compounding, your gains have the opportunity to make more gains – all tax-free.

When your child is ready to use 529 funds, you’ll withdraw the money tax-free also, as long as it is being used to pay for qualified education expenses. Some states offer additional income tax benefits. For example, South Carolina residents who save in  are allowed to deduct 100% of the contributions they make to Future Scholar accounts on their state income taxes.

What Are 529 Plan Distributions?

529 plan distributions are the funds you withdraw from the account. Funds can be withdrawn for both qualified and non-qualified expenses. Knowing the difference between the two can make all the difference when tax time arrives.

Are 529 Distributions Taxable?

529 plan distributions are free of federal income taxes as long as they are used to pay for qualified education expenses. That means when you withdraw funds from a 529 account to pay for things like tuition or room and board, neither you nor your child will have to report that money as income on a tax return or pay additional taxes come tax season.

What are qualified 529 education expenses?

This is one of the most common questions about investing in a 529 plan. So, here’s a breakdown of qualified 529 education expenses:

• Tuition and fees at eligible higher educational institutions – including two- and four-year public and private colleges throughout the U.S., many international schools, graduate and professional programs, trade schools, and registered apprenticeship programs.
• Room-and-board expenses, as long as the on-campus or off-campus expenses do not exceed the school’s “cost of attendance” for federal financial aid calculations as listed on the school’s website.
• Textbooks that are included on the required reading list for a given course.
• Computers and related equipment or supplies that are required for enrollment or attendance at an eligible higher educational institution.

But that’s not all. Over the years, federal regulations have expanded the definition of a qualified expense to include:

• K-12 tuition at public, private, or religious elementary or secondary schools.
• Expenses for special needs services necessary for enrollment or attendance at an eligible higher education institution.
• Expenses for fees, books, supplies, and equipment required to participate in certified apprenticeship programs.

And while every parent’s goal of saving with a 529 account is to spare their child from incurring excessive student loan debt, it’s great to know that 529 funds can also be used to pay back qualified student loans.

Withdrawal Limits

If you plan to use 529 plan funds to help pay for qualified K-12 education expenses or to pay down student loan debt, you’ll need to consider these withdrawal limits:

For K-12 private school tuition, you may withdraw up to $10,000 per beneficiary per year tax-free. This limit applies regardless of the number of 529 accounts for the beneficiary. For example, if both the parents and grandparents own 529 accounts for the same child, the $10,000 maximum would apply to both accounts combined.

For student loan debt, 529 plans have a lifetime withdrawal limit of $10,000 per beneficiary or sibling of the beneficiary. Of course, the more funds you save in a 529 account, the less debt a student incurs. That's yet another reason to open a 529 account and save early and save often.

Requesting Distributions

Another common question about 529 distributions is, “Do the funds have to be paid directly to the school, or can I reimburse myself from the 529 account?” Both options are available. As long as the funds are being used to pay for qualified expenses, or do not exceed any amount already paid out-of-pocket for qualified expenses.

When it’s time to withdraw your 529 funds, the most efficient way to request funds is electronically through the plan’s secure account owner portal. For most plans, there are a variety of ways to receive funds, including electronically depositing them into your bank account or sending the funds directly to the school. Either way, it’s important to plan ahead. It may take a few days to process the withdrawal and many schools have strict deadlines for payment.

Timing is Important - Take Distributions the Same Year as Payment

Withdrawing 529 money at the right time is crucial. 529 distributions are only qualified (tax-free) if they are taken in the same calendar year you paid for the qualified expense.

For example, your child will be attending school in January 2025. The tuition bill arrives in December 2024. You decide to write a check from your personal bank account to pay the university in December and plan to reimburse yourself from the 529 account. For the withdrawal to be qualified (tax-free), you must withdraw the funds from your 529 account to reimburse yourself before the end of 2024.

On the other hand, if you wait to pay the bill from your personal checking account in January, you can withdraw the funds from your 529 account to reimburse yourself anytime in 2025 for it to be a tax-free distribution.

Many plans, like South Carolina’s Future Scholar 529 Plan, allow account owners to take a distribution from their 529 account and send it directly to the school. This is a great way to keep track of your distributions and also ensures they are made within the appropriate tax year.

For other expenses, it’s smart to keep all of your receipts in a central location. Then, as the end of the calendar year approaches, you can go through your receipts to make sure you have withdrawn funds to pay for all qualified education expenses.

529 Distribution Penalties

At the end of the day, the funds in your 529 account belong to you. While using your 529 funds for qualified education expenses allows you to take advantage of investment earnings tax-free, you can still withdraw funds for non-qualified expenses. Just keep in mind, in most cases a 10% federal penalty will be applied to those earnings. Because the funds in your 529 account were contributed after taxes, there will be no taxes on the principal portion of your account.

The exception to this rule is if the account beneficiary receives a scholarship. A non-qualified distribution from the account up to the value of the scholarship can be made without incurring the 10% penalty.

Start Saving Today with Future Scholar

A 529 savings plan offers many benefits to a family that values education. If you haven’t yet opened an account, getting started is easier than you think – learn more about how a Future Scholar 529 college savings account can help you reach your savings goals.