Financial Planning

529 Accounts: The Ins and Outs of Qualified Expenses

As you may know, 529 accounts are a great savings vehicle for many individuals to save money for education. The IRS allows funds in this account to grow without being subject to tax until a distribution is made, and depending on the type of expense, the proceeds can even be tax free! To determine the taxability of the distribution, the IRS looks at the purpose of the expense and groups them into two categories: qualified and nonqualified expenses.

Qualified expenses are what the IRS deems to be an expense related to the beneficiary’s education, while expenses deemed not to be directly related are classified as nonqualified expenses. If you make a distribution from the account for a qualified expense, you won’t have to pay any tax or penalties on the amount distributed. Sounds great, right? Just remember to keep any receipts for these expenses to support your tax return when it comes time to file. Below is a list of some common examples of qualified expenses found on the IRS website.

Examples of Qualified Expenses:

  • Tuition and fees at a higher education school, which includes trade schools.
  • Books, supplies, and equipment (including a computer used for school).
  • Room & board expenses for students enrolled at least half-time, up to the school’s determined allowance. This includes expenses such as rent, utilities, and groceries.
  • Tuition expenses associated at an elementary or secondary, public, private, or religious school (i.e., K-12), up to a total of $10,000 per year.
  • Qualified student loans up to $10,000 paid on behalf of the student or the student’s sibling.

While the IRS doesn’t list any specific examples of nonqualified expenses, these types of expenses generally include costs that aren’t directly incurred as a result of education, for example, a new car or furniture for a dorm or apartment. If you withdraw funds from a 529 account for a nonqualified expense, you will be subject to tax and a 10% penalty, but only on the portion of your account that is considered to be earnings. This means you will never be subject to tax or penalties on the amount you contributed to the account.

If the institution issues a refund for some or all of the expenses you paid and you are no longer able to claim it as a qualified expense, the IRS has a special provision that allows taxpayers to avoid unnecessary taxes and penalties. If you return the funds into the account within 60 days of receiving the refund, the IRS will not count this as taxable income.

529 accounts can indeed be a great savings vehicle for many, but it’s important to understand how they can be used to their fullest potential to ensure you are getting the most value. If you have any questions, please reach out to our office.

If you are a grandparent and interested in learning more about 529 accounts please read, Give Your Grandchild the Gift of a 529 College Savings Plan, which was featured in one of our recent newsletters.