Can you make a tax-free withdrawal from a 529 plan for qualified education expenses incurred before you set up the account? Yes, as long as you incurred the expenses in the same calendar year. The IRS does not require that 529 withdrawals be traceable to specific educational expenditures. Here’s how to account for 529 withdrawals:
After year-end, add up all of the beneficiary’s qualified education expenses for the year. Add up all 529 withdrawals. As long as (2) is smaller than (1), you won’t have to worry about federal income tax. The withdrawn earnings are tax-free.
What happens if (2) is bigger than (1)? You have to go to Step 3–calculating how much of the earnings portion of your withdrawal is taxable, and, possibly, subject to a 10 percent federal penalty. In November 2002, the IRS came out with Publication 970 containing instructions for this purpose. You (or, more likely, your tax advisor) can use these instructions to compute the amount of income subject to tax and penalties.
