FAMILY TAX PLANNING · 6 MIN READ
What Is a 529 Plan? Tax Benefits, Withdrawal Rules, and Penalty Exceptions
By Hevia & Hevia CPA Firm · Published
A 529 plan is an education savings arrangement that allows investment earnings to grow without current federal income tax and generally be withdrawn tax-free for qualifying education expenses. Nonqualified withdrawals generally make the earnings portion taxable and subject to a 10% additional tax, although exceptions may apply.
Understanding which expenses qualify—and what an exception actually eliminates—can help families avoid an unexpected tax bill.
Federal rules summarized as of November 2, 2026.
How does a 529 plan work?
There are two principal types: education savings plans and prepaid tuition plans.
An education savings plan holds contributions in investment options offered by the program. A prepaid tuition plan purchases specified future tuition benefits under its contract. Their investment risks, guarantees, and permitted uses can differ.
Contributions generally come from after-tax money and are not deductible on your federal income tax return. The principal benefit is the favorable treatment of earnings when distributions satisfy the rules. IRS: 529 plan overview
What expenses can a 529 plan cover?
A 529 savings plan can cover more than a traditional four-year college education.
| Expense | Important qualification |
|---|---|
| College, graduate school, and eligible vocational education | Tuition, required fees, books, supplies, and equipment can qualify. |
| College room and board | The student generally must attend at least half-time, and applicable cost limits apply. |
| Computers and internet access | Must satisfy the education-related use requirements. |
| Registered apprenticeships | Required fees, books, supplies, and equipment can qualify. |
| Certain postsecondary credentials | Eligible credential programs, examinations, and related expenses must meet statutory requirements. |
| K–12 education | Beginning in 2026, qualifying expenses are subject to a combined $20,000 annual limit per beneficiary across their 529 accounts. |
| Qualified student loans | Eligible repayments are subject to a $10,000 lifetime limit per individual. |
The expanded K–12 rules cover specified expenses beyond tuition, including certain curriculum materials, tutoring, testing, and disability-related educational therapies. Not every school-related purchase qualifies. IRS: Qualified tuition programs
What happens if I withdraw money for another purpose?
A nonqualified withdrawal generally contains both contributed money and investment earnings. The contributed portion is generally not taxed again; the taxable earnings portion ordinarily faces income tax and the additional 10% tax.
You generally cannot designate a withdrawal as consisting entirely of your original contributions to avoid the earnings calculation.
Buying a car for a college student, for example, does not become a qualified education expense simply because the student needs transportation. Confirm eligibility before requesting a distribution. SEC: Questions to consider about 529 accounts
What are the exceptions to the 10% additional tax?
The additional tax may not apply in the following circumstances, subject to the applicable conditions and limits:
| Circumstance | How the exception generally applies |
|---|---|
| Death of the beneficiary | Certain distributions paid to the beneficiary or the beneficiary’s estate qualify. |
| Disability of the beneficiary | The disability must meet the applicable tax-law standard. |
| Tax-free scholarship or fellowship | Relief is limited by the qualifying scholarship amount. |
| Veterans’ benefits or other qualifying tax-free educational assistance | Relief is limited by the qualifying assistance received. |
| Attendance at a U.S. military academy | Relief is limited by the applicable academy education costs. |
| Coordination with education credits | Relief may apply when earnings become taxable solely because expenses were allocated to the American Opportunity or Lifetime Learning Credit. |
These are exceptions to the additional tax—not necessarily to ordinary income tax on the earnings. IRS Publication 970, Chapter 7
What if my child receives a scholarship?
A qualifying tax-free scholarship can allow a corresponding 529 withdrawal without the 10% additional tax. However, the earnings portion generally remains subject to ordinary income tax unless another exclusion applies.
The exception applies only up to the qualifying scholarship amount. It does not make the entire 529 account available for a penalty-free withdrawal.
Example: A $10,000 scholarship
Suppose your child receives a $10,000 tax-free scholarship, and you take a corresponding $10,000 nonqualified 529 distribution. Assume the plan reports that the distribution consists of:
- $7,000 of original contributions: generally not taxable.
- $3,000 of investment earnings: generally taxable as ordinary income.
If the scholarship exception’s requirements are met, the 10% additional tax on the $3,000 of earnings—$300—would not apply. Ordinary income tax on those earnings would generally remain due. Who reports that income depends on who receives the distribution.
Can I use the account for expenses the scholarship does not cover?
Yes. You may still take tax-free 529 distributions for remaining qualifying expenses, such as eligible books, equipment, or qualifying room and board.
However, expenses covered by a tax-free scholarship cannot also support a tax-free 529 withdrawal. Expenses used for an education credit must also be coordinated.
Do I have to withdraw the scholarship amount?
No. Receiving a scholarship does not require you to withdraw money or close the account. You may retain funds for future qualifying education, consider a qualifying family-member beneficiary change, or evaluate an eligible Roth IRA rollover.
Before requesting a scholarship-related withdrawal, retain the award letter, confirm the scholarship’s tax treatment and restrictions, and coordinate the distribution’s amount and timing with your tax advisor. IRS Publication 970, Chapter 7: Qualified Tuition Programs
Can unused 529 money be transferred to a Roth IRA?
A limited rollover to the beneficiary’s own Roth IRA may qualify, but this is not an unrestricted way to cash out unused savings.
Important requirements include:
- A $35,000 aggregate lifetime limit for the beneficiary.
- Satisfaction of the 15-year account requirement.
- Exclusion of contributions made during the preceding five years and their attributable earnings.
- A direct trustee-to-trustee transfer.
- Compliance with the applicable annual IRA limit, reduced by other IRA contributions.
- Sufficient qualifying compensation under the applicable rules.
Confirm eligibility and the plan’s procedures before initiating the transfer. IRS Publication 590-A: 529-to-Roth rollovers
Can I change the beneficiary or return a school refund?
Changing the beneficiary to a qualifying family member generally does not create a taxable distribution. However, certain changes can raise separate gift or generation-skipping transfer tax questions.
If a school refunds qualified expenses previously funded by a 529 distribution, the refunded amount may generally be recontributed to a 529 account for the same beneficiary within 60 days of the refund, subject to the statutory requirements. Keep the refund and recontribution records. Internal Revenue Code Section 529
What should Florida families consider?
Florida does not impose a personal income tax, so Florida residents do not receive a Florida personal income tax deduction for their contributions.
Families should still compare fees, investment options, prepaid-plan contract terms, and any benefits available through another relevant state. Federal qualification does not automatically establish identical treatment in every state. Florida Prepaid College Board: College savings basics
What records should I keep?
Retain account statements, Form 1099-Q, tuition bills, receipts, scholarship information, enrollment records, and documentation supporting any exception or transfer.
Coordinate withdrawals with expenses paid in the same calendar year. Also coordinate scholarships and education credits so that the same expense is not used for incompatible tax benefits.
At Hevia & Hevia CPA Firm, we help families evaluate how education savings, distributions, and tax credits fit into their broader tax picture.
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