529 Plan Penalty: Approved Expenses and How to Avoid Fees
It’s no wonder that 529 plans are one of the most popular options for education savings accounts. The NC 529 Plan offers a unique set of benefits to account holders. It allows for both regular and occasional contributions, so there’s no pressure to add funds each month to keep it open. Not only that, but you can live anywhere in the country — not just in North Carolina — and take advantage of saving with the NC 529 Plan.
Most people would say the NC 529 plan’s top perk is its tax benefits. Earnings grow and remain tax-free when withdrawn for qualified education expenses. But every now and then, the unexpected happens, and you may consider withdrawing funds for non-qualified expenses. Or maybe you have leftover funds sitting in the account after your child has graduated from college and aren’t sure how else to use them.
Before you take this step, educate yourself on what expenses will trigger a penalty. In this guide, we’ll explain the “fine print” on non-qualified withdrawals so you can decide if the 529 withdrawal penalty is worth it for you and your family.
What are Qualified Education Expenses (QEE)?
Most people know 529 plans as savings accounts for college. But college expenses are just one of many ways to use your tax-exempt earnings. The list below includes the Qualified Education Expenses, or QEE, which are tax-free withdrawals for NC 529 Account holders. Before you assume that your needed expense will hit you with the 529 plan penalty, check to see if it’s identified on this list.
- College expenses. Tuition, books, fees, supplies, and room and board all fall into this category. The NC 529 Plan will also cover the cost of a computer for your child to use in college, plus school-related equipment, software, and internet access.
- Career/Technical/Apprenticeship program expenses. Career programs are a great option for students who want a quicker path to a hands-on career, such as an electrician, dental hygienist, or radiology technician. Programs often take no more than two years and generally cost much less than a traditional four-year college degree. Make sure the school of interest is on the Federal Student Aid list for these expenses to be eligible. For apprenticeship programs, check that they’re registered with the S. Department of Labor or a State Apprenticeship Agency.
- K–12 tuition. You don’t have to wait until your child is college-bound to use your tax-advantaged NC 529 Account earnings! Use up to $10,000 of NC 529 funds per year, per child, to pay for their private or public K–12 education.
- Special needs equipment. Use earnings tax-exempt toward these expenses if your child has learning differences that require special equipment or technology for their education.
- Student loan payments. As of 2019, NC 529 earnings can be used toward student loan payments on behalf of the beneficiary or their siblings — up to $10,000 per individual!
- Roth IRA rollovers. Starting in 2024, beneficiaries of accounts that have been open for at least 15 years are eligible to roll over up to $35,000 to a Roth IRA without a 529 tax penalty.
Understanding the 529 Plan Penalty
If your expense doesn’t fit into one of the above categories, you may be subject to the 529 withdrawal penalty. Here’s what to expect if you choose to make a non-qualified withdrawal from your NC 529 Account:
What Happens When I Make a Non-Qualified Withdrawal?
- An automatic 10% penalty, in addition to state and federal income taxes. Earnings that are withdrawn become subject to these taxes; and the amount you withdraw should be included when you calculate your federal taxable income and any applicable state income tax.
- A $50 processing fee is deducted from the withdrawal. The NC 529 plan penalty includes this one-time fee in addition to your withdrawal amount.
When filing taxes for the year you took the non-qualified withdrawal, the penalty and taxes become the participant’s obligation. Learn more about the 529 plan penalty in the NC 529 Program Description.
Examples of Non-Qualified Expenses & Withdrawals
Some families mistakenly assume that certain expenses are eligible for tax-free withdrawals but find out the hard way when shelling out taxes and fees on these purchases. Here are some common examples of non-qualified expenses that can incur the 529 plan penalty:
- College application fees. If your child applies to many colleges, these fees can add up. Unfortunately, they’re not qualified expenses under the 529 plan.
- Is your child applying to a school out of state? Keep in mind that travel costs to and from campus do not qualify.
- Extracurricular activities. Clubs and teams may charge fees to participate, but the NC 529 Plan doesn’t cover these fees.
How to Avoid Penalties and Fees
With the NC 529 Plan, there are many ways to use the funds without paying a cent in taxes. Whenever possible, we recommend holding on to your funds to reap all the benefits of the NC 529 Program. Think about these options if you’re unsure whether the 529 withdrawal penalty is the right choice:
- Change the beneficiary on the account. Do you have another child who will be attending college? Save any leftover funds for their future education. You can even change the beneficiary to yourself and go get that degree!
- Just tight on funds? You can always adjust your contributions within the rules of the program. Making occasional contributions won’t cost you in fees, and you can always go back to your saving level once your financial situation improves.
Ultimately, you know what’s best for you and your family, and you’re entitled to use your savings as needed. If you weigh the benefits and drawbacks and decide to make the non-qualified withdrawal, you can easily do so by completing a withdrawal form.
Saving With An NC 529 Account Is Always Worth It
When your goal is to save for education in the savviest way possible, it’s hard to beat the NC 529 Plan. Get to know all the NC 529 program highlights, and remember that it’s never too early or too late to start saving. Open an NC 529 Account today in minutes with as little as $25. Whatever the future brings, you’ll be ready to face it.