IRS Section 529 Rules: Qualified Expenses, Taxes, and Penalties

Section 529 of the Internal Revenue Code lets you save for education in an account where investment earnings grow free of federal income tax and come out tax-free when spent on qualified education expenses. The IRS rules for Section 529 plans set the contribution limits (through the gift tax system), define what counts as a qualified expense, and impose a 10% penalty on earnings withdrawn for anything else. Legislation signed in July 2025 expanded the K-12 spending cap and added new categories of qualified expenses starting January 1, 2026.

Contribution Limits and the Gift Tax Rules

The IRS does not set an annual dollar cap on 529 contributions. Each state sets an aggregate lifetime limit for its own plan, generally ranging from about $235,000 to over $620,000. Once contributions plus growth hit the cap, new contributions stop, but existing money keeps growing.

Contributions are treated as gifts under federal tax law. In 2026, a single person can contribute up to $19,000 per beneficiary without triggering gift tax or a gift tax return.¹ A married couple can combine exclusions and give $38,000.

Section 529 also allows a special five-year accelerated gift. One person can put in up to $95,000 at once, and a married couple up to $190,000, treated for gift tax purposes as if spread evenly over five years.² You must file IRS Form 709 for the year of the contribution and make no additional gifts to that beneficiary for the next four years. If the contributor dies before the five years are up, the unused years’ allocations are pulled back into their taxable estate.

How Earnings and Withdrawals Are Taxed

Money inside a 529 grows without any federal income tax on dividends, interest, or capital gains each year.² When you take money out for qualified education expenses, the earnings portion also comes out federally tax-free.

Every withdrawal has two parts: your original contributions, which were made with after-tax money and always come back tax-free regardless of how they’re spent, and accumulated earnings, which only escape tax when spent on qualified expenses. Good records matter, because at withdrawal time you need to be able to separate the two.

What Counts as a Qualified Expense

Higher Education

At colleges, universities, and vocational schools, qualified expenses include tuition, mandatory enrollment fees, books, supplies, and equipment required for courses.³ Computers, software, and internet access qualify if the beneficiary primarily uses them for school. The school itself must be an eligible educational institution, meaning it participates in the federal student aid program, which covers almost all accredited public and private nonprofit postsecondary schools in the U.S. and many abroad.⁴

Room and board qualifies only if the student is enrolled at least half-time. On-campus housing counts up to whatever the school actually charges. Off-campus housing is capped at the room-and-board allowance the school uses for federal financial aid. Anything spent above that allowance is not a qualified expense.

K-12 (Expanded for 2026)

Starting January 1, 2026, the annual cap on tax-free 529 withdrawals for K-12 expenses doubled from $10,000 to $20,000 per beneficiary. That cap is an aggregate federal limit across every 529 account any relative may hold for the same student.

The 2026 rules also broadened what counts as a K-12 qualified expense beyond tuition:

Books, online educational resources, and structured homeschool curricula
Academic tutoring by a licensed teacher, a current or former teacher at an eligible institution, or a subject matter expert who is not related to the student
Standardized tests, AP exams, and college entrance exams such as the SAT and ACT
Tuition for dual-enrollment college courses taken during K-12
Occupational, behavioral, physical, and speech-language therapy for students with disabilities, when provided by a licensed or accredited practitioner

Apprenticeships and Credentials

Fees, books, supplies, and equipment for any apprenticeship program registered with the U.S. Department of Labor are qualified 529 expenses. Postsecondary credentialing programs also qualify, including programs authorized under the Workforce Innovation and Opportunity Act, military credentials, and other government-approved credential programs. Tuition, fees, books, supplies, equipment, and required testing or continuing education fees for these programs are all qualified.³

Student Loan Repayment

You can withdraw up to $10,000 over the beneficiary’s lifetime to pay principal or interest on their qualified education loans.² The $10,000 cap applies separately to each of the beneficiary’s siblings, so a family with three children could use up to $30,000 across all three.

What Doesn’t Qualify

Transportation, health insurance premiums billed separately from tuition, and non-mandatory student activity fees are not qualified expenses.

Coordinating With Education Tax Credits

You cannot use 529 money and claim an education tax credit like the American Opportunity Tax Credit on the same dollar of expenses. The qualified expenses eligible for tax-free 529 withdrawal must be reduced by any amount used to generate a credit.²

The AOTC is worth up to $2,500 per student per year for the first four years of college, and 40% of it is refundable. Many families are better off paying enough tuition from outside the 529 to claim the full credit, then using 529 funds for the remaining qualified expenses. Overlooking this coordination either forfeits the credit or turns part of the 529 withdrawal into a non-qualified distribution.

Penalties for Non-Qualified Withdrawals

Withdraw money for anything other than a qualified expense and the earnings portion is taxed as ordinary income at the recipient’s marginal rate, plus a 10% additional federal penalty.⁵ Your original contributions come back tax-free regardless.

The plan administrator issues Form 1099-Q after any distribution, reporting the gross amount in Box 1 and the earnings portion in Box 2. Any penalty owed is calculated on Form 5329 with your return.

The 10% penalty is waived in a few specific situations, though the earnings remain taxable as ordinary income:

Death or permanent disability of the beneficiary
Tax-free scholarships, veterans’ educational assistance, or employer-provided educational assistance received by the beneficiary — the waiver applies up to the amount of the award
Attendance at a U.S. military service academy — the waiver applies up to the cost of attendance

Any withdrawal beyond the scholarship, award, or academy cost remains subject to the full 10% penalty on earnings.

Changing Beneficiaries and Rolling Over Accounts

You can change the beneficiary on a 529 without tax consequences as long as the new beneficiary is a family member of the previous one. The IRS defines family broadly: spouses, children, siblings, parents, nieces, nephews, first cousins, and in-laws all qualify.²

You can also roll funds from one state’s 529 into another’s without federal tax, once per beneficiary in any 12-month period, with the transfer completed within 60 days. Many states will recapture any income tax deduction previously claimed on the outbound account, so check state rules before moving money.

529 funds can be rolled into an ABLE account for the beneficiary or a family member with a qualifying disability. The rollover must happen within 60 days, and the amount counts toward the ABLE account’s annual contribution limit for the year. This option is now permanent, having previously been set to expire at the end of 2025.

Rolling Unused Funds Into a Roth IRA

Leftover 529 money can be rolled into a Roth IRA in the beneficiary’s name, subject to a $35,000 lifetime cap and several conditions:²

The 529 account must have been open for at least 15 years
Contributions made within the last five years, along with their earnings, are not eligible
Each year’s rollover cannot exceed the beneficiary’s annual Roth IRA contribution limit ($7,500 in 2026 for someone under 50) and is shared with any other Roth contributions they make that year
The beneficiary must have earned income at least equal to the rollover amount

At the $7,500 pace, reaching the full $35,000 takes about five years of rollovers.

Financial Aid Treatment

A parent-owned 529 is reported as a parent asset on the FAFSA and can reduce need-based aid by up to 5.64% of the account’s value. A $50,000 balance might reduce aid by roughly $2,800. The same money in a student-owned bank account would be assessed at 20%.

Under the current FAFSA rules (effective with the 2024–2025 cycle), distributions from a grandparent-owned 529 are no longer reported as student income. Before that change, grandparent distributions could reduce aid by as much as 50 cents per dollar.

Estate Planning Notes

Contributions to a 529 are completed gifts for federal transfer tax purposes and are removed from the donor’s taxable estate. The five-year accelerated election lets a grandparent move $95,000, or $190,000 as a married couple, out of the estate in a single year while retaining the ability to change beneficiaries later.¹

If the contributor dies before the five years are up, the portion allocated to remaining years is included in the gross estate. Someone who front-loads $95,000 and dies in year three would have $38,000 added back to their estate for the final two years’ allocations.

1
Internal Revenue Service. Gifts and Inheritances
2
Office of the Law Revision Counsel. 26 USC 529 – Qualified Tuition Programs
3
Internal Revenue Service. Topic No. 313, Qualified Tuition Programs (QTPs)
4
Internal Revenue Service. Eligible Educational Institution
5
Internal Revenue Service. Form 1099-Q Instructions