IRS 529 Plan Questions and Answers: Expenses, Penalties, Rollovers

A 529 plan follows a simple bargain at the federal level: money grows tax-free inside the account, and withdrawals come out tax-free when spent on qualified education expenses. Step outside those expenses and the earnings portion of the withdrawal gets taxed as ordinary income plus a 10% penalty. The rules governing 529 plans and qualified expenses cover more than college tuition, but they interact with gift tax reporting, education tax credits, and financial aid formulas in ways that catch people off guard.

What Counts as a Qualified Education Expense

Qualified expenses fall into four buckets: higher education, K-12 tuition, registered apprenticeships, and student loan repayment.

College and Post-Secondary Costs

Tuition, mandatory fees, books, supplies, and equipment required for enrollment at an eligible institution all qualify. An eligible institution is any accredited college, university, vocational, or other post-secondary school that participates in federal student aid programs.¹

Room and board qualify only if the student is enrolled at least half-time. On-campus housing qualifies up to the actual amount the school charges. Off-campus housing qualifies up to the school’s published cost-of-attendance allowance for room and board.¹ Computers, software, and internet access qualify when the beneficiary uses them primarily for school. Sports, game, and hobby software does not, unless it is predominantly educational.

K-12 Tuition

You can withdraw up to $20,000 per beneficiary per year tax-free for tuition at a public, private, or religious elementary or secondary school.¹ The cap is a per-beneficiary annual limit across all 529 accounts held for that beneficiary, and it applies to tuition only. Books, supplies, and other K-12 costs do not qualify.

Registered Apprenticeships

Fees, textbooks, supplies, and required tools for a registered apprenticeship program qualify. The program must be certified and registered with the U.S. Department of Labor under the National Apprenticeship Act.

Student Loan Repayment

Up to $10,000 in 529 funds can go toward qualified student loans. That is a lifetime limit per individual, not an annual one. The beneficiary and each of the beneficiary’s siblings can each use up to $10,000 toward their own loans, so a family with three children could apply as much as $30,000 across all of them.

What Does Not Qualify

Transportation, health insurance premiums, and extracurricular or sports expenses outside the required curriculum do not qualify. Spending 529 money on any of these triggers both income tax and the 10% penalty on the earnings portion of the withdrawal.

What Happens When You Withdraw for Something Else

Only the earnings portion of a non-qualified withdrawal is taxed. Your original contributions come back tax-free because they went in with after-tax dollars. The earnings are taxed as ordinary income at the recipient’s marginal rate, plus a 10% additional federal tax.¹

The plan administrator reports every distribution to the IRS on Form 1099-Q, showing the split between earnings and principal.² The IRS does not automatically match your withdrawals to your expenses. The account owner or beneficiary has to keep receipts and records to show, if asked, that each withdrawal lined up with qualified spending. Withdrawals and the expenses they pay for must fall in the same tax year. If a distribution ends up in the wrong year by mistake, you have 60 days to roll it back into a 529 plan to undo the tax hit.

When the 10% Penalty Is Waived

Several situations waive the 10% additional tax while still leaving the earnings taxable as ordinary income:

The beneficiary receives a tax-free scholarship or grant. Withdrawals up to the scholarship amount avoid the penalty.
The beneficiary dies or becomes disabled.
The beneficiary attends a U.S. military academy. Withdrawals up to the cost of advanced education at that academy avoid the penalty.
Expenses used to claim the American Opportunity Tax Credit or Lifetime Learning Credit are matched by a 529 withdrawal. The earnings on that portion are still taxable, but no penalty applies.¹

Coordinating With Education Tax Credits

This is the trap. You can claim the American Opportunity Tax Credit or the Lifetime Learning Credit in the same year you take 529 distributions, but the same dollar of expense cannot support both. Expenses used for the credit have to come off your qualified education expenses before you calculate how much of the 529 withdrawal is tax-free.³

Say your child has $15,000 in qualified expenses and you claim the AOTC on $4,000 of them. Your adjusted qualified expenses for 529 purposes drop to $11,000. If you withdrew the full $15,000 from the 529, $4,000 of the withdrawal is non-qualified, and the earnings on that $4,000 are taxable as ordinary income. The penalty is waived because of the education credit exception, but the income tax still applies. The way around this is to reduce the 529 withdrawal by whatever amount of expense you plan to use for the credit.

Contribution Limits and the Gift Tax

Anyone can contribute for any beneficiary, regardless of relationship. There is no federal income tax deduction for contributions. The main federal restriction is the gift tax, because every dollar you put into a 529 counts as a gift to the beneficiary.

For 2026, the annual federal gift tax exclusion is $19,000 per donor per recipient.⁴ Contribute up to that amount and no reporting is required. Contributions above $19,000 require the donor to file Form 709, though filing rarely means owing gift tax. The excess just reduces your lifetime estate and gift tax exemption.⁵

A special election lets you front-load up to five years of contributions in a single year. For 2026, that means one donor can put up to $95,000 into one beneficiary’s account at once, with Form 709 filed to spread the gift ratably over five years.¹ Married couples splitting gifts can double that to $190,000. Once you make the election, further tax-free gifts to the same beneficiary have to wait four years or dip into the lifetime exemption.

Each state sets its own aggregate account balance cap for a single beneficiary, typically somewhere between about $235,000 and nearly $600,000 across all accounts in that state’s plan. When the balance hits the cap, the plan stops accepting new contributions, though the existing balance keeps growing. Many states also offer their residents a state income tax deduction or credit for contributions to the home state’s plan, separate from the federal treatment.

Changing Beneficiaries and Rolling Over Leftover Funds

The account owner keeps control and can change the beneficiary at any time without tax consequences, provided the new beneficiary is a family member of the original one. Family is defined broadly: siblings, parents, children, stepchildren, nieces, nephews, aunts, uncles, first cousins, in-laws, and spouses of any of those.¹

You can also roll funds from one 529 to another, including across state lines, tax-free. That is limited to one rollover per beneficiary in any 12-month period.

Rolling Into a Roth IRA

Since 2024, the SECURE 2.0 Act allows tax-free rollovers from a 529 plan into the beneficiary’s Roth IRA. The restrictions are strict:

The 529 plan must have been open for at least 15 years.
The lifetime rollover cap to a single beneficiary’s Roth IRA is $35,000.
Each year’s rollover cannot exceed that year’s Roth IRA contribution limit ($7,000 for most beneficiaries under 50 in 2026).
Contributions made to the 529 within the past five years, and their earnings, are not eligible.
The funds must transfer directly from the 529 to the Roth IRA. You cannot take a distribution and redeposit it yourself.

The Roth IRA has to be in the beneficiary’s name, not the account owner’s. A Roth rollover does not count against the once-per-12-months limit on 529-to-529 rollovers.¹

How Ownership Affects Financial Aid

Financial aid treatment depends on who owns the account. Under the current FAFSA formula, a parent-owned 529 is a parent asset, which reduces aid eligibility by at most 5.64% of the account value. A 529 owned by a dependent student is a student asset, assessed at up to 20%.

Grandparent-owned accounts used to be a real problem. Under the old FAFSA, distributions from a grandparent’s 529 counted as untaxed student income and could cut aid eligibility by as much as half of the withdrawal. The redesigned FAFSA changed this. Student income now flows in through an automated exchange from federal tax returns, and qualified 529 distributions do not appear on those returns. So grandparent-owned 529 distributions generally no longer reduce need-based federal aid.

About 200 colleges use the CSS Profile for institutional aid, and those schools may still ask about family financial support. Their treatment of grandparent 529 funds varies. Merit-based aid, by definition, is unaffected by anyone’s 529 holdings.

Naming a Successor Owner

A 529 plan does not pass through a will. Instead, the account owner names a successor owner who takes over if the owner dies. Most plans also let you name a contingent successor. The successor gets full control, including the power to change the beneficiary, adjust investments, or take a non-qualified withdrawal. The beneficiary stays put unless the successor changes it.

Naming a successor keeps the account out of probate. Skip this step and the account may end up in your state’s probate process, which delays access to the funds. Each account allows only one primary successor, who must be a U.S. resident with a U.S. mailing address and at least 18 years old.

1
Office of the Law Revision Counsel. 26 USC 529 – Qualified Tuition Programs
2
Internal Revenue Service. About Form 1099-Q, Payments From Qualified Education Programs
3
Internal Revenue Service. Publication 970, Tax Benefits for Education
4
Internal Revenue Service. Frequently Asked Questions on Gift Taxes
5
Internal Revenue Service. About Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return