Avoiding tax penalties on 529 Plan funds – not all expenses are qualified

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If you have accumulated a sizeable amount of funds in a 529 college savings account, how can you get these funds out without having to pay tax penalties? If you inadvertently use funds for the wrong expenses, you will end up being taxed on the earnings, as well as levied a 10% penalty on that amount. Although 529 plan accounting tends to operate on the honor system, as you have to track your own expenses, using funds for the wrong items could have consequences in the event of an IRS audit.


Qualified expenses include tuition and room and board. If your child is planning to live off-campus, in housing not owned or operated by the college, you are unable to claim expenses in excess of the school’s estimates for room and board for attendance. It is important to confirm room and board costs with the school’s financial aid office, in advance, so you know what to expect. Also, keep in mind that, in order for room and board to qualify, your child must be enrolled half time or more. Room and board costs in excess of the amount the school includes in its "cost of attendance" figures for federal financial aid purposes are not qualified. Books and supplies, along with computers or related equipment, are also qualified expenses.


Although there are several other expenses that seem related to college such as transportation costs and travel, these expenses are not qualified. Funds from a 529 plan cannot be used towards the purchase of a car, fuel costs, or public transportation costs to and from school. Any insurance (car, health etc.) cannot be paid with 529 funds either. If your child is a member of a school club or involved in a sports activity, any related fees and costs are also not qualified. It might seem intuitive that, if you have a student loan, you can use funds from a 529 to pay off the balance, but this is also not permitted.


If your child is studying abroad, check with the school to find out if the study abroad program qualifies for 529 funds. Tuition, fees, and textbooks are always qualified expenses, provided that the student is at least a half-time student and attending an IRS-designated eligible educational institution. Room and board charges can be qualified expenses as long as they are approved under a direct educational expense (Needs to be a dormitory located at the university and not a private apartment, even if it is cheaper). Travel cost and international healthcare costs are also not qualified for 529 funds. 



References:

 

https://www.irs.gov/credits-deductions/individuals/qualified-ed-expenses

 

https://www.fidelity.com/learning-center/personal-finance/college-planning/college-529-spending

 

https://www.savingforcollege.com/article/what-you-can-pay-for-with-a-529-plan

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