California 529 Plan: Tax Rules, Qualified Expenses, and Aid Impact

The California 529 plan, known as ScholarShare 529, is the state’s official college savings program. It lets you invest after-tax money for a beneficiary’s education and withdraw both your contributions and all investment earnings free of federal and California income tax, as long as the money goes toward qualified education expenses.¹ California does not offer a state income tax deduction or credit for what you put in, which is the trade-off for the tax-free growth coming out.

You open an account with as little as $25, and you keep control of it for the life of the account.² The beneficiary never automatically takes ownership, even after turning 18. You can be any adult with a Social Security number or taxpayer ID, and you don’t need to live in California.³

Tax Treatment for California Residents

Contributions go in with after-tax dollars. There is no federal deduction for 529 contributions to any state’s plan.¹ California also offers no state deduction or credit, unlike roughly 30 other states that reward contributions to their home plans.

The benefit arrives on the way out. Qualified distributions come out entirely tax-free at both the federal and California level, covering your original contributions and every dollar of investment growth on top of them.¹ On an account held for 15 or 18 years, the earnings portion can match or exceed what you put in, and none of it is taxed when used for education.

The California K-12 Exception

This is the one tax rule most likely to catch California account owners by surprise. Starting in 2026, federal law allows up to $20,000 per year per beneficiary in 529 distributions for K-12 tuition across all 529 accounts.⁴ California does not conform. For California taxpayers, the earnings portion of any K-12 withdrawal is subject to state income tax plus an additional 2.5% California tax.³ Federal tax is still waived. California tax is not. If your account has had time to grow, that bite on the earnings can be meaningful.

What Counts as a Qualified Expense

Qualified expenses at an eligible educational institution come out tax-free at both the federal and California level, with the K-12 carve-out noted above. The list is broader than many account owners realize:

Tuition and mandatory fees at any accredited college, university, or vocational school nationwide.
Room and board, but only while the student is enrolled at least half-time. The tax-free amount is capped at the greater of the school’s published cost-of-attendance allowance or the actual invoice for on-campus housing.⁵
Books, supplies, and equipment required for enrollment.
Computers, software, printers, and internet service used by the beneficiary during enrollment. Equipment used primarily for entertainment does not count.¹
Fees, books, supplies, and required tools for apprenticeships registered with the U.S. Department of Labor.
Up to $10,000 in lifetime student loan repayments per individual. The limit applies separately to the beneficiary and to each sibling of the beneficiary.⁵
Up to $20,000 per year per beneficiary in K-12 tuition at public, private, or religious schools (federally tax-free, California-taxed on earnings).

If the school refunds tuition after a withdrawal or course drop, you have 60 days from the refund date to redeposit the money into a 529 account for the same beneficiary. Miss that window and the original withdrawal is treated as non-qualified. When you redeposit, notify the plan in writing that the deposit is a re-contribution tied to a specific refund, and keep the paperwork linking the two.

Non-Qualified Withdrawals

Pulling money out for anything else triggers tax on the earnings portion only. Your contributions always come back tax-free and penalty-free because you already paid tax on that money. On the earnings, you owe:

Federal ordinary income tax plus a 10% additional federal tax.⁵
California income tax plus a separate 2.5% California additional tax.²

The 10% federal penalty is waived (though income tax on the earnings still applies) when the distribution is:

Made after the beneficiary’s death or paid to their estate.
Made because the beneficiary is disabled.
Offset by a tax-free scholarship, veterans’ educational assistance, or employer-provided educational assistance, up to the amount of the scholarship or benefit.
Made because the beneficiary attends a U.S. military academy.
Included in income only because the same expenses were used to claim the American Opportunity or Lifetime Learning credit.⁶

The California 2.5% additional tax follows its own rules. Check the Franchise Tax Board’s guidance for the year in question before assuming the federal waiver carries over.

Contribution Ceilings and Gift Tax

ScholarShare caps the maximum balance per beneficiary at $529,000 across all accounts in the plan. Contributions that would push the total above that line are rejected and returned. Market gains above the ceiling can stay and keep earning, but new contributions won’t be accepted until the balance drops back under.⁴

The plan itself sets no annual contribution limit, but federal gift tax rules do. The 2026 annual gift tax exclusion is $19,000 per recipient.⁷ A married couple can contribute $38,000 per beneficiary in a year without filing a gift tax return.

A five-year election lets you front-load. Under this rule, you can contribute up to $95,000 per beneficiary in one year ($19,000 × 5) and treat it as if spread evenly across five tax years for gift tax purposes. Married couples using gift-splitting can contribute up to $190,000 at once.⁵ You file IRS Form 709 for the year of the contribution and for each of the remaining four years. If you die during the five-year window, the portion allocated to years after your death is pulled back into your taxable estate.

If the Money Isn’t Needed

You can change the beneficiary at any time, free, with no federal income tax consequences, as long as the new beneficiary is a qualifying family member of the current one. The IRS defines that circle broadly: siblings, step-siblings, parents, grandparents, aunts, uncles, first cousins, in-laws, and their spouses. A change to someone outside that circle is treated as a non-qualified distribution.

Since 2024, under the SECURE 2.0 Act, leftover 529 money can be rolled into a Roth IRA for the beneficiary. The conditions are strict:

The 529 account must have been maintained for the beneficiary for at least 15 years.
Only contributions (and their earnings) deposited at least five years before the rollover date are eligible.
Each year’s rollover counts against the beneficiary’s annual Roth IRA contribution limit, which is $7,000 for 2026 ($8,000 if the beneficiary is 50 or older).
The lifetime cap is $35,000 per beneficiary.⁵
The transfer must go trustee-to-trustee into a Roth IRA in the beneficiary’s name.

At $7,000 a year, hitting the $35,000 lifetime cap takes a minimum of five years of rollovers. The 15-year clock and the five-year seasoning requirement mean accounts opened late in a child’s life won’t qualify in time.

How a 529 Affects Financial Aid

A parent-owned 529 is reported as a parental asset on the FAFSA. Parental assets are assessed at a maximum rate of 5.64% in the Student Aid Index calculation, so a $50,000 balance reduces aid eligibility by at most about $2,820 per year. Student-owned assets are hit at 20%, so parent ownership is the lighter treatment.

Grandparent-owned accounts improved starting with the 2024-2025 FAFSA. The simplified form no longer requires students to report cash support or distributions from a grandparent’s 529. The old penalty, which could reduce aid by up to half the distribution amount, is gone on the federal form.

The CSS Profile, used by many private colleges for their own institutional aid, is a different story. It may still ask about 529 accounts owned by grandparents or other relatives, and those balances can affect a school’s own aid offer. Factor this in if the student is applying to CSS Profile schools.

Opening a ScholarShare Account

You can open an account online or by paper application. You’ll need your Social Security number or taxpayer ID and the same for the beneficiary. The minimum initial contribution is $25, and you can fund the account by electronic bank transfer, check, or payroll deduction where the employer participates.² After opening, you pick your investment portfolio and can set recurring contributions. ScholarShare lets you change investment selections twice per calendar year, or any time you change the beneficiary.

1
Internal Revenue Service. 529 Plans: Questions and Answers
2
ScholarShare 529. Frequently Asked Questions
3
ScholarShare 529. How Does A 529 Plan Work In California
4
ScholarShare 529. ScholarShare 529 Plan Description
5
Office of the Law Revision Counsel. 26 USC 529 – Qualified Tuition Programs
6
Internal Revenue Service. Publication 970 – Tax Benefits for Education
7
Internal Revenue Service. Frequently Asked Questions on Gift Taxes