When Can You Use a Section 529 Plan?

Merrill Lynch Wealth Management explains the uses of and limits to this popular education savings tool.


Millions of Americans use 529 plans to sock away money for their kids’ and grandkids’ education. They are popular, in part, because of the tax benefits they can provide: withdrawals, including any earnings, are federal, and possibly state, income tax free when they are used for qualified education expenses. Previously only applicable to college-related expenses, effective January 1, 2018, 529 plan holders can also use up to $10,000 per calendar year per beneficiary to help pay for tuition at an elementary or secondary public, private or religious school.

Besides tuition and fees — the biggest educational bills you will probably face — other eligible expenses include such things as room, board, books, required supplies, the purchase of computer and peripheral equipment, computer software, or Internet access and related services, and certain expenses in the case of a special-needs beneficiary, as defined by the Internal Revenue Code.

But there are limits to what sorts of expenses are allowed. “Using 529 funds to pay for a music degree at an accredited institution for your daughter would be fine, but if you use them to pay for private piano lessons, you will be penalized,” says Richard J. Polimeni, director of the Education Savings Programs at Bank of America Merrill Lynch. “That penalty essentially means you have to pay income tax on the earnings portion of the money you withdrew, as well as a 10% additional federal tax.” However, you will never pay income tax or the additional federal tax on the principal portion of your withdrawal, regardless of what it is used for.

The rules are fairly flexible when it comes to how many students can benefit from your 529 account. “Suppose you set aside $200,000 in an account for your daughter and you spend only half of the money,” Polimeni explains. “You could transfer the rest to an account for another family member of the beneficiary, for example, your son or even a niece or nephew.” If there is something left over, it can stay in the account indefinitely — and be ready, decades later, to help pay the cost of a grandchild’s education. Or it could even be used to fund your own or your spouse’s continuing education.

If you want to set aside money for lessons or other educational activities that a 529 account does not cover, you could consider a trust or a custodial account under the Uniform Gifts/Transfer to Minors Act (UGMA/UTMA). However, there are potential drawbacks to that strategy, Polimeni warns. “These gifts cannot be taken back and do not allow you to transfer assets between beneficiaries. And once the child you designate as beneficiary reaches age of majority — which varies by state — he or she will be free to spend the money for purposes other than education. “If that is a concern, you may decide you are better off using a typical savings or investment account to earmark money for educational goals that a 529 account does not cover,” Polimeni says. “Working together with your outside tax and legal specialists, and your financial advisor can help you figure out what makes the most sense for your family.”


[1]For distributions after December 31, 2017, qualified higher education expenses include tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school. These distributions are limited to $10,000 per calendar year, across all 529 accounts for the same beneficiary. State tax treatment may vary.


For more information, contact Merrill Lynch, Franz Koch in the Boca Raton office at 561-393-4583 or [email protected].

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