With the average price of a private four-year college in the United States (including tuition, fees, and room and board) rising to nearly $48,510 a year,1 many people are concerned about how to fund their child's education. Fortunately, 529 plans can be a way to save for college.
Named after the IRS code section that created it, a 529 plan is a tax-advantaged investment plan that's designed to encourage saving for future higher education expenses of your beneficiary (typically a child or grandchild). Plans are administered by state agencies and organizations as a way for people to save for qualified educational expenses such as tuition, room and board, and textbooks. But do you have to use 100 percent of the money in your 529 plan for college related expenses? Simply put, yes.
According to the IRS, 529 plan rules state that the money you withdraw must be used for qualified higher education expenses. These expenses include tuition, fees, books, and room and board (if the student is attending school at least half-time) for college and graduate school. If used for any other purpose, you may be subject to income taxes, plus an additional 10 percent federal tax penalty on your earnings.2
Keep in mind that you, the 529 plan owner, are the one subject to taxation and any penalties - not your beneficiary. There can be exceptions to the penalty. For example, if you close the account due to your beneficiary (the student) passing away or has become disabled, or if money is withdrawn because it's no longer needed due to the student receiving scholarship funds.
NOTE: As of 2018, the IRS has amended the term “qualified higher education expense” to include a limited amount of annual expenses from a 529 Plan for tuition at an elementary or secondary public, private, or religious school. Source: www.irs.gov/newsroom/529-plans-questions-and-answers.