Can someone explain how you can use scholarships to offset 529 withdrawals? And…does that apply just to merit scholarships, or also to need-based grants provided by the college/university?
Thanks!
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Had you already made a withdrawal and since received a scholarship, and you want to recontribute it?
You will get better answers if you can be more specific as to what you are asking about. Are you asking about how scholarships can reduce Qualified Education Expenses? Are you asking about how scholarships received can be used to provide an exception to the 10% additional tax (“penalty”) when a 529 distribution exceeds Qualified Education Expenses? The 529 rules make no distinction between merit scholarships and need-based grants… both are considered tax-free educational assistance, which is the term that the IRS uses.
Thank you!
I think I am asking how need-based institutional grants can be used to avoid the 10 percent penalty for excess 529 withdrawals.
Can the grants also be leveraged to avoid taxes on those withdrawals?
If you haven’t already done so, you should read the applicable part of IRS Pub 970, Tax Benefits for Education. The language about exceptions to the 10% “penalty” (additional tax) on non-qualified 529 distributions can be found on page 62.
2020 Publication 970 (irs.gov)
No, grants and scholarships cannot also be leveraged to avoid taxes on non-qualified distributions.
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D20 gets need-based institutional grant money from her school and they automatically deduct the amount of the grant from her account balance before sending the bill. We arrange for the amount to be sent from the 529 directly to the school. At the end of the calendar year, we got the appropriate forms from the 529 and the school showing equal amounts. The school’s policy is that overpayments will be refunded. If the amount paid exceeds the amount billed, that still gets reported.
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If a college is applying grants/scholarships towards your tuition bill, then the remaining balance are the qualified expenses you can pay from your 529.
If your withdraw more from your 529 than actual expenses for that period, then you are not using the money as agreed-upon when you decided to receive a multi-year tax benefit, hence the penalty.
If possible, retain the money in the 529, and use it after college for graduate school. Who knows, you might seek a masters or decide on a second degree. Or, possibly even transfer the benefit to another family member for them to afford private/boarding school, their college education, etc.
Thank you all! You have given me a lot to think about – as well as a very lengthy IRS document to peruse (which I really appreciate – I always like to see that actual source documents).