1.6.2.4. Withdrawals
Not only does the balance of a 529 account grow tax-free at the federal level, but withdrawals for qualified education expenses are federally tax-free as well. (State taxation of 529 accounts varies.) Qualified education expenses include the following expenses for higher education: tuition, non-tuition fees, books, school supplies, school equipment (such as computers), room and board for students who attend at least half-time and live in student housing, and expenses associated with special needs services if the beneficiary is a special needs student.
529 education savings plans were originally intended to be used only for higher education, including universities, community colleges, apprenticeship programs, and trade schools. At the beginning of 2018, the definition of qualified education expenses was loosened slightly to include up to $10,000 per year of the beneficiary’s elementary or secondary school tuition. This exception only applies to tuition. Non-tuition fees, books, and all the other types of education expenses listed before are qualified only when they are for higher education. As of 2020, qualified education expenses also include up to $10,000 worth of student loan payments (total, not per year) for the beneficiary or beneficiary’s siblings, as well as expenses associated with apprenticeship programs.
Let’s look at how a withdrawal would be treated differently by the IRS, depending on the withdrawal’s purpose. Suppose a 529 account has a balance of $10,000, of which $8,000 is principal from the contributor and $2,000 is from the account’s growth. The contributor wants to withdraw $1,000. Funds are always withdrawn from a 529 account on a proportional basis between earnings and principal, so the $1,000 withdrawal consists of $800 in principal and $200 in earnings.
The $800 in principal is never taxed, because it isn’t any sort of income or gain. The $200 in earnings is not taxed (at least not at the feder