California 529 Withdrawal Rules: Taxes, Penalties, and Rollovers

California 529 withdrawal rules follow federal law for traditional college costs but diverge in several places that catch ScholarShare account owners by surprise. Money you take from a ScholarShare 529 is free of federal and California income tax when it pays for qualified higher education expenses. If it pays for anything else, the earnings portion of the withdrawal faces ordinary federal income tax, a 10% federal additional tax, California income tax, and a 2.5% California additional tax. And a handful of uses that Congress made tax-free at the federal level, including K-12 tuition and 529-to-Roth rollovers, still count as non-qualified for California purposes.

What a Qualified Withdrawal Covers

At the federal level, qualified higher education expenses include tuition, mandatory enrollment fees, books, supplies, and equipment required for coursework at an eligible postsecondary institution or vocational program.¹ Required computers and specialized lab gear count, as do special-needs services tied to the beneficiary’s enrollment.

Room and board qualify only when the student is enrolled at least half-time in a degree or certificate program. The amount you can cover with 529 funds is capped at the greater of the school’s published room-and-board allowance in its cost of attendance, or the actual charge for housing the school owns or operates.² For a student living off campus, the school’s cost-of-attendance figure for that living arrangement sets the ceiling.

Expenses tied to federally registered apprenticeship programs also qualify, with no annual cap, and California matches the federal treatment on this one.³ Traditional postsecondary tuition, fees, books, and room and board are fully tax-free on both the federal return and the California return.

Where California Breaks From Federal Rules

California’s tax code conforms to federal 529 rules only as of a specific date, and the legislature has not adopted every expansion Congress has added since. The practical result: several withdrawals that are tax-free federally still count as non-qualified for California, triggering state income tax and a 2.5% additional California tax on the earnings portion.

K-12 Tuition

Congress added K-12 tuition as a qualified 529 use in 2018, capped at $10,000 per beneficiary per year.⁴ California has not conformed. Withdrawing ScholarShare funds for elementary or secondary tuition means the earnings portion owes California income tax plus the 2.5% additional state tax, regardless of the amount.³

Student Loan Repayment

Federal law treats student loan repayment as a qualified 529 use subject to a $10,000 lifetime limit per beneficiary, and the same limit extends to repaying loans held by the beneficiary’s siblings. That provision came in 2019, after California’s conformity date. Based on California’s general conformity framework and the pattern with other post-2017 provisions, withdrawals used for student loan repayment are likely treated as non-qualified for California tax purposes. Confirm the current Franchise Tax Board position before taking a distribution.

529-to-Roth IRA Rollovers

The SECURE 2.0 Act allowed tax-free rollovers from 529 plans to Roth IRAs starting in 2024, capped at $35,000 per beneficiary over a lifetime and limited each year to the beneficiary’s IRA contribution limit. California explicitly does not conform. The Franchise Tax Board treats these rollovers as non-qualified distributions, so the earnings portion is subject to California income tax and the 2.5% additional tax.⁵ A rollover with significant accumulated earnings can produce a meaningful California tax bill even though the federal return reports nothing.

Registered Apprenticeships

California does treat withdrawals for registered apprenticeship program expenses as qualified and free from state income tax, matching federal treatment.³ This is the exception to the conformity pattern.

What a Non-Qualified Withdrawal Actually Costs

Taxes and penalties on a non-qualified withdrawal apply only to the earnings portion. Your original contributions come back untouched because they were made with after-tax dollars.

Federally, the earnings are added to taxable income at your ordinary rate and then hit with a 10% additional tax.⁶ California adds state income tax at your applicable rate plus the 2.5% additional California tax.³

Here is what that looks like on a $10,000 non-qualified withdrawal consisting of $6,000 in original contributions and $4,000 in earnings. The $6,000 comes back tax-free. The $4,000 in earnings owes federal income tax at your marginal rate, the 10% federal penalty ($400), California income tax at your state rate, and the 2.5% California additional tax ($100). In the 22% federal bracket and the 9.3% California bracket, the total tax on that $4,000 is roughly $1,752.

ScholarShare reports every distribution on IRS Form 1099-Q, which breaks out the gross distribution, the earnings portion, and your basis. The form goes to whoever actually receives the money. A check mailed to the account owner produces a 1099-Q in the owner’s name; a check sent directly to the beneficiary produces one in the beneficiary’s name.⁷ That person is responsible for determining whether the distribution was qualified and reporting any taxable earnings.

When the 10% Federal Penalty Is Waived

Several situations waive the 10% federal additional tax even though the withdrawal is technically non-qualified. The earnings still owe ordinary federal income tax and California income tax; only the federal penalty disappears.

Death or permanent disability of the beneficiary.
A withdrawal up to the amount of any tax-free scholarship, fellowship, or Pell grant the beneficiary receives.
A withdrawal up to the amount of tax-free veterans’ educational assistance received by the beneficiary.
Attendance at a U.S. military academy, up to the cost of attendance.
A withdrawal matching tax-free employer tuition benefits received by the beneficiary.

The scholarship exception is the one families run into most. A common mistake is leaving 529 money alone because a scholarship covered the bill. Pulling out the scholarship-equivalent amount still triggers income tax on the earnings, but the 10% penalty is waived and the funds return to the account owner’s hands instead of sitting unused.²

Tuition Refunds and the 60-Day Recontribution Window

If the school issues a tuition refund (from a dropped class, a mid-semester withdrawal, or a late scholarship) and the original payment came from 529 funds, you have 60 days from the date of the refund to recontribute the money into any 529 plan for the same beneficiary. Meet the deadline and the IRS treats the transaction as if the non-qualified distribution never happened, with no tax or penalty on the earnings.²

Miss the window and the refunded amount becomes a non-qualified distribution, with income tax and the 10% federal penalty on the earnings portion. Schools do not coordinate with 529 administrators, so tracking the refund date and acting on it falls to the account owner.

Timing and Records

The calendar-year matching rule trips up more account owners than any other procedural requirement. A 529 withdrawal must occur in the same calendar year as the qualified expense it covers, not the same academic year. Paying a spring-semester tuition bill in January 2026 but not withdrawing the 529 funds until February 2027 produces an unmatched, potentially non-qualified distribution. For tuition that posts in December for a January semester, watch whether the payment lands before or after December 31.

ScholarShare lets you send funds directly to the school, to yourself, or to the beneficiary through its online portal. Direct payment to the institution simplifies documentation, but the withdrawal and the expense still need to fall in the same tax year.

The IRS generally requires taxpayers to keep supporting records until the statute of limitations closes on the relevant return, usually three years from filing, or six years if income is underreported by more than 25%.⁸ Six years is the safer practice for 529 withdrawals since the IRS could argue unreported earnings extend the limitations period. Keep tuition invoices, receipts for books and supplies, housing contracts or leases, and the school’s Form 1098-T for each year you take distributions. The burden of proving a withdrawal was qualified sits with the account owner.

Coordinating With Education Tax Credits

You can claim the American Opportunity Tax Credit or the Lifetime Learning Credit in the same year you take a tax-free 529 distribution, but you cannot use the same dollar of expense for both. The IRS requires you to subtract any expenses used for a credit before working out how much of the 529 withdrawal is tax-free.²

The American Opportunity Credit is worth up to $2,500 and is calculated on $4,000 of qualifying expenses. A common approach is to pay the first $4,000 of tuition from non-529 money to capture the full credit, then cover remaining expenses with ScholarShare withdrawals. Running both against the same expenses does not double the benefit; it just shrinks the tax-free portion of the 529 withdrawal and can create a partially taxable distribution for no reason.

1
Office of the Law Revision Counsel. 26 USC 529 – Qualified Tuition Programs
2
Internal Revenue Service. Publication 970 (2025), Tax Benefits for Education
3
ScholarShare 529. How Our 529 Works
4
Internal Revenue Service. 529 Plans – Questions and Answers
5
Franchise Tax Board. 2024 Instructions for Form FTB 3805P
6
Internal Revenue Service. 1099-Q What Do I Do?
7
Internal Revenue Service. Form 1099-Q (Rev. April 2025) – Instructions for Recipient
8
Internal Revenue Service. Topic No. 305, Recordkeeping