529 Plan Changes

529 plans are tax-advantageous plans to save for educational expenses, and they just received a major upgrade.

I wanted to cover them so that you are aware of all the changes:

1. Section 70413. Additional expenses treated as “qualified higher education expenses”

One of the limitations of 529 plans was that you weren’t able to use them on certain costs outside of tuition.

So, parents of a high school child who attends a public school weren’t able to use their 529 plans to offset some costs, but that changes with the following expenses qualifying for students attending a public, private, or religious K–12 school:

1. Tuition
2. Curriculum and curricular materials (i.e., any specialized courses needed as part of the enrollment in class)
3. Books or other instructional materials
4. Online educational materials
5. Tuition for tutoring or educational classes outside of home (tutor must not be a family member and must be licensed) as part of the enrollment or attendance of K–12 school (so doesn’t apply for homeschooled children). For example, say your child is struggling with math in high school or even middle school. Tutoring could be classified as an eligible distribution for purposes of the 529 plan.
6. Fees for a nationally standardized achievement test, an advanced placement examination, or any examinations related to college or university admission (think ACT/SAT tests, AP exams)
7. Fees for dual enrollment in an institution of higher education (for example, say your high school child takes college credits)
8. Educational therapies for students with disabilities provided by a licensed provider (huge!)

The effective date for these changes applies to distributions made after “the date of the enactment of this Act” which is July 4, 2025.

So, for any distributions after such a date, these expenses will be qualified on the federal level.

Quick note – different states do it differently, and this will apply to all the 529 changes discussed in this email.

Some states say “we will follow whatever the IRC Section 529”, also called conforming 529 states (about 20 states). Some states say “we create our own rules” also called non-conforming states.

So, it’s important to check what your state will end up doing.

Example:

Say you pay $150 for your child’s AP exam. It’s a qualified educational expense on the federal side due to the new bill, so no taxes there.

But if you live in, say, California, they generally don’t recognize this as a qualified educational expense (unless they enact a law, but let’s assume they don’t).

You would have to pay state income taxes on the earnings portion of the withdrawal. If your $150 withdrawal had $100 of contributions and $50 of earnings, you will pay taxes on $50 (about $2-5 of taxes), and California also has an additional 2.5% penalty on non-qualified distributions ($1.25).

2. Increased limit

Additionally, OBBBA increases the annual limit for these types of expenses from $10,000 to $20,000 per year beginning in 2026.

This probably doesn’t really matter unless your child is attending a private school.

3. Section 70414. Certain postsecondary credentialing expenses treated as “qualified higher educational expenses”

I’m also excited about this change.

Many people didn’t want to contribute to 529 plans because of “what if my child doesn’t go to college!”

This section helps ease that concern a bit.

This new section covers tuition, fees, books, supplies, and equipment required for enrollment or attendance in a recognized postsecondary credential program. It also covers fees for testing and fees for continuing education required to maintain a credential.

So, what is a “recognized postsecondary credential”?

It means any credential if:

> Any postsecondary credential that is industry-recognized and is issued by a program that is accredited by the Institute for Credentialing Excellence (for example, Certified Information Systems Security Professional (CISSP))

> Any certificate of completion of an apprenticeship that is registered with the Secretary of Labor (for example, finishing an electrician apprenticeship program that earns a certificate)

> Any occupational or professional license issued or recognized by a state or federal government (CPA license, yay!)

> Any recognized postsecondary credential as defined in Section 3(52) of the Workforce Innovation and Opportunity Act

Note that it’s not just enough to earn a certificate. The program itself must qualify and be a legitimate pathway to earn that credential. The bill defines programs that are on official state lists under WIOA, listed in the Veterans Benefits directory, or identified by the Secretary as reputable programs.

AOTC credit

Many people don’t know, but you can actually use a 529 plan to capture the American Opportunity Tax Credit (AOTC).

The AOTC is a credit for qualified educational expenses paid for a student for the first four years of higher education.

You get a $2,000 credit for $2,000 of eligible expenses and 25% for the next $2,000 of expenses, totaling a $2,500 credit for $4,000 of maximum expenses if your income limit qualifies.

Now, if your 529 plan balance is low, you can just pay $4,000 out of pocket for the eligible expenses and then use the rest to pay out of the 529 plan. This way, you are maximizing tax credits and letting the 529 grow.

But, if you have a large 529 plan balance and don’t want it to grow too large as withdrawals are limited to educational expenses, you can use a 529 withdrawal to get the credit.

While this is considered a taxable distribution, it’s not subject to a 10% additional penalty since it was “included in income only because the qualified education expenses were taken into account in determining the American Opportunity or Lifetime Learning Credit” (Publication 570, page 53).

But, some of the amount will be taxable.

Example:

Say you withdrew $10,000 from a 529 plan to cover eligible tuition expenses. You also took an AOTC for $4,000 of expenses. Your total adjusted qualified eligible expenses will be $6,000. From the $10,000 withdrawal, say $5,000 of it was contributions and $5,000 is the earnings (growth of the account).

You will have:

$5,000 × $6,000 ÷ $10,000 = $3,000 of tax-free earnings, and $2,000 will be taxable (Schedule 1 (Form 1040), line 8z) income. With a 22% marginal rate, that’s ~$440 of taxes for a $2,500 credit.

I’m personally excited about the changes. I think it’s beneficial and are a lot more practical for taxpayers with children.

Hope you enjoyed this one.

Chat next week,

MC, CPA