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A 529 plan is a tax-advantaged way to save for college, but you need to follow the rules when you take money out. Breaking the rules could mean running afoul of the IRS — and facing a significant tax bill.

Let’s look at how 529s work and how you can use the money in the plan to help cover college expenses without getting into tax trouble.

What is a 529 plan and how does it work?

A 529 plan is a savings and investment account designed to be used to pay for a variety of qualified education expenses. You can choose between two types of 529 plans.

  • Prepaid tuition plans allow you to purchase future college credits (usually from a public, in-state college or university) at today’s prices. This can be a great deal if you know for sure where your young child will go to college in the future.
  • Education savings plans are investment accounts that let you save for future educational expenses and use the funds at any college or university. This is a good option if you want your child to have more college choices.

In this article, we’ll focus on education savings plans.

You can learn more about how to pay for college through Credible, where you can also compare your prequalified rates for private student loans from multiple lenders.

Tax benefits of 529s

A 529 college savings plan has several tax advantages. All states have 529 plans, but the tax advantages vary from state to state.

For example, many states allow deductions or tax credits on state income tax returns for contributions to a 529 plan. But some states only offer deductions for contributions made to an in-state plan, while other states allow deductions for contributions to any plan. Invesco has a useful summary of 529 tax benefits by state if you want to look up your state’s rules.

Contributions to a 529 plan aren’t deductible on your federal income tax return, but as long as the money stays in the account, you don’t have to pay federal taxes on the earnings. And as long as you use the money to pay for qualified expenses, those withdrawals are also tax-free on your federal return and possibly your state taxes as well.

What expenses can I pay with a 529 plan?

To benefit from tax-free withdrawals from a 529 plan, you can’t spend the money on just anything — you have to use the funds to pay for “qualified education expenses” as defined by the IRS’s 529 plan rules in Publication 970. They include …

  • Required college tuition and fees
  • Any books, supplies, and equipment required by a college or university for attendance or enrollment
  • Expenses for special-needs services
  • College room and board expenses (as long as the student is enrolled at least half-time)
  • Computers, computer equipment, software, and internet access while enrolled in a college or university
  • Fees, books, supplies, and equipment required as part of an apprenticeship program
  • Student loan payments (limited to $10,000 per year)
  • K-12 tuition (limited to $10,000 per year)

Can I use 529 funds to pay my student loans?

Until recently, you weren’t allowed to use 529 plan funds to pay student loans. But that changed with the Setting Every Community Up for Retirement Enhancement Act of 2019, also known as the SECURE Act.

Now, as long as you take the 529 plan distribution after Dec. 31, 2019, you can withdraw up to $10,000 from your 529 plan account tax-free and put it toward paying off qualifying student loans. You can use the money to pay for either federal student loans or private student loans.

To qualify for tax-free treatment, the student loan must belong to the account beneficiary or the beneficiary’s sibling.

What if I use my 529 plan for non-qualified expenses?

Withdrawals from a 529 plan are tax-free as long as you use the money to pay for qualified higher education expenses. But what happens if you use the money for non-qualified expenses?

To understand what happens with non-qualified withdrawals, you must first understand that each withdrawal has two parts: your original contribution to the account and investment earnings.

Both the contribution and earnings portion of your withdrawal will be shown on the Form 1099-Q you receive from the plan — earnings in box 2 and contributions, also known as basis, in box 3.

You’ll use those amounts to calculate taxes and penalties on the earnings portion of the distribution.


You must include the earnings portion (box 2 of Form 1099-Q) in your taxable income for the year. But you can reduce the taxable earnings by any tax-free scholarships and grants, veterans educational assistance, and employer-provided education benefits you received during the year. The tax rate you’ll pay on the remaining amount depends on your tax bracket and overall tax situation.


You may also have to pay a 10% tax penalty on the amount included in income. But there are several exceptions to the penalty. Those exceptions are explained in detail in IRS Publication 970 and include payments …

  • Made after the death of the account beneficiary.
  • Made to a beneficiary after they become permanently disabled.
  • Used for advanced education for U.S. military academy students.
  • Included in income only because the qualified education expenses were used to claim a tax credit, such as the American Opportunity Tax Credit or the Lifetime Learning Credit.

What happens if I have money left in my 529?

Knowing how much you need to save in a 529 plan isn’t an exact science, so what happens if you or your child don’t need all the money you saved? That money is still yours, and you have a few options.

  • Hold on to it. Money saved in a 529 plan isn’t just for traditional college degrees. You can use it to cover classes at any college, university, or vocational school. So you may want to keep the money in the account to pay for graduate school or continue your education in the future.
  • Change the beneficiary. The IRS doesn’t penalize you for changing the beneficiary to another member of the family. For example, parents may want to become the beneficiary of the plan and use funds to continue their own education or roll them into a sibling’s 529 plan.
  • Cash it out. Money in a 529 plan is always yours to withdraw, so you can withdraw the money for any reason and pay taxes and penalties on the earnings. But keep in mind that if you have a prepaid tuition plan, you may only be allowed to withdraw your contributions to the plan and would lose out on any earnings.
  • Roll it into an ABLE account. IRS 529 plan rules allow you to roll funds from a 529 plan into an Achieving a Better Life Experience (ABLE) account for the same beneficiary or a family member. ABLE accounts are tax-advantaged savings accounts for people who become disabled before age 26.

Alternatives for students and parents who don’t have a 529

If you don’t have a 529 and still need help paying for college, here are some other options to consider.

Financial aid

If you’re looking at a college or university’s published tuition, fees, room, and board, you may wonder how anyone affords an education. But there’s a difference between the “sticker price” of a college tuition and what most students pay.

On average, students pay about 70% of the sticker price at for-profit institutions and 40% to 45% of the sticker price at public and private nonprofit universities, according to a report from the Urban Institute. So be sure to fill out the Free Application for Federal Student Aid (FAFSA) Form each year. Colleges use information from your FAFSA to determine federal financial aid as well as their own financial aid. This may include grants, scholarships, and work-study jobs.

Each college or university you apply to should send you an aid offer explaining the types and amounts of financial aid they can offer and your expected costs for the year.

Private scholarships

Many companies, nonprofit organizations, and community groups offer private scholarships to students who meet certain requirements. Talk to your high school guidance counselor or the financial aid office at the school you plan to attend, or search online using the U.S. Department of Labor’s Scholarship Finder to start researching and applying for scholarships.

Take out student loans

When it comes to paying for college, it’s a good idea to look first at sources you don’t have to pay back. But if scholarships and grants won’t cover your costs, consider student loans.

  • Federal student loans: Federal student loans will be presented to you in the award letter received from the colleges to which you’ve been accepted. As a first-year undergraduate student, you can borrow up to $5,500 per year in federal student loans, or $9,500 if you’re not dependent on your parents. You can learn more about federal student loans via the U.S. Department of Education.
  • Private student loans: If federal student loans don’t provide enough aid to cover your tuition, room, and board, you can consider private student loans to cover the rest of your expenses. The amount you can borrow with private student loans depends on several factors, including the lender’s loan limits, your credit history, and whether or not you have a cosigner.

Credible makes it easy to compare student loan interest rates from multiple lenders.

Claim other tax breaks for education

You (or your parents if you’re on their taxes as a dependent) can recoup some of the money you spend on education by taking advantage of one or more tax breaks.

  • The American Opportunity Tax Credit (AOTC) is worth up to $2,500 per year for the first four years of your undergraduate education. To qualify, you must be enrolled at least half-time in a degree program. If your available credit is greater than your tax bill, you can receive up to $1,000 of the credit as a tax refund. To claim the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 if married and filing a joint tax return). The credit is gradually phased out if your income is above those limits and phased out entirely once your income is above $90,000 ($180,000 if married filing jointly).
  • The Lifetime Learning Credit (LLC) is worth up to $2,000 per year. You don’t have to be enrolled at least half-time or even be pursuing a degree program, and it’s available for any year of study. The LLC isn’t refundable if your available credit is greater than your tax bill for the year. The credit is gradually phased out if your MAGI is between $59,000 and $69,000 ($118,000 and $138,000 if you’re married and file a joint tax return). Above those upper limits, the credit isn’t available.
  • The student loan interest deduction allows you to deduct up to $2,500 of interest paid on qualified student loans. You don’t have to itemize deductions to claim it. For 2020 tax returns, your student loan interest deduction is gradually phased out if your MAGI is between $70,000 and $85,000 ($140,000 and $170,000 if married and filing a joint return). You can’t claim the deduction if your income is above those upper limits. Those income limits are adjusted annually for inflation.

Keep in mind that the IRS generally doesn’t allow you to use the same expenses for more than one tax break. For example, if you withdraw $2,000 from a 529 plan to pay tuition, you can’t use that same $2,000 to claim the AOTC.

If you’re employed, check if your company offers tuition assistance

If you have a job, your employer can provide up to $5,250 in tuition assistance, also known as employer-paid tuition assistance, as a tax-free fringe benefit. This means the tuition assistance isn’t taxable income to you, but your employer can claim a tax deduction for the benefits it provides. Eligible expenses include tuition, fees, textbooks, supplies, and equipment.

There’s no income phase-out, and the exclusion from income is available for an unlimited number of years.

About the author: Janet Berry-Johnson is an authority on income taxes and small business accounting. She was a CPA for over 12 years and has been a personal finance writer for more than five years. Janet has written for several well-known media outlets, including The New York Times, Forbes, Business Insider and Credit Karma. In 2021, Canopy named her one of the Top 10 Influential Women in Accounting and Tax.

About the author
Janet Berry-Johnson
Janet Berry-Johnson

Janet Berry-Johnson is an authority on income taxes and small business accounting. She was a CPA for over 12 years and has been a personal finance writer for more than five years. Janet has written for several well-known media outlets, including The New York Times, Forbes, Business Insider and Credit Karma. In 2021, Canopy named her one of the Top 10 Influential Women in Accounting and Tax.

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