Tips for 529 withdrawals for the first year of college

A milestone for high school graduates — and for their parents — is coming soon. Students will be starting college, and the parents will be getting the first tuition bill. Now’s the time to talk to parents, grandparents, and others with 529 college savings plans for first-year college students about taking withdrawals. Here are some withdrawal tips.

Know what’s a qualified expense

Remind clients that withdrawals must be used for qualified expenses to be tax-free. Tuition isn’t the only qualified expense. Think education essentials.

• School tuition: Tuition and fees for post-secondary schools, vocational and trade schools, and elementary or secondary school
• Living essentials: On-campus room and board, meal plans, off-campus rent (up to the cost of on-campus room and board), or special needs accommodations
• Classroom essentials: Books, school supplies, electronic devices, and computer software required by the school
• Additional uses: Internet access fees or student loan repayments ($10,000 lifetime limit)

Remind clients that if they use 529 plan funds for non-qualified expenses, they'll have to pay federal income taxes and a 10% penalty on the earnings portion of the withdrawal. 

Maximize other tax credits first

If a client qualifies for the American Opportunity Tax Credit (AOTC), up to $2,500 per student when they spend $4,000 on tuition, fees, and textbooks, or the Lifetime Learning Tax Credit (LLTC), up to $2,000 per student, they can still take advantage of one per year and pay for qualified expenses with a 529 plan.¹ (Each tax credit has adjusted gross income limits.) They may want to plan to pay the tax credit amount from another account, so they can get the tax credit. They cannot claim the AOTC or LLC on expenses that are paid from a 529 plan, though.

Decide who gets the funds

Money from a 529 plan can be disbursed to the account owner to pay the student beneficiary’s expenses, the student beneficiary, or the educational institution. Direct payments to schools can ensure that funds are used as intended, but account owners should check to see how the school handles 529 plan payments. 

Time withdrawals by tax year

Tax years and academic years don’t align. Withdrawals made from 529 plans must be used during the current tax year to qualify for the tax benefits. Remind them that college academic years can span two calendar years. For instance, the spring term, which typically begins in January, is usually billed in December. If they withdraw the funds in December, they need to pay the bill before Jan. 1. If they plan to pay the expense after Jan. 1, they need to withdraw 529 plan funds after that date to avoid taxes.

Coordinate withdrawals from multiple 529 plans

If the student is a beneficiary on other 529 plans — from a grandparent, aunt, uncle, or family friend, for instance — it’s important to coordinate withdrawals. Account owners need to discuss withdrawals and coordinate who will pay which expenses. It’s critical for them not to withdraw money that won’t be used for qualified expenses in that same tax year. The account owner would have to pay taxes and a penalty on the earnings portion.

Good news for the 2023–2024 school year: Withdrawals from a grandparent or non-parent-owned 529 plan will not be considered student income. They don’t need to be reported on a student’s Free Application for Federal Student Aid (FASFA®) application starting this year. 

Don’t stop saving

If a client hasn’t saved enough to cover four years of college expenses, encourage them to keep contributing if they can. This gives the money the potential to grow tax-free, and they may also get a state tax deduction.

Remind parents that just as they saved diligently for college in a 529, they need to be diligent when they take withdrawals and when and how they use the money. It’s just as important.

Get more 529 plan ideas on our resources page.