We have some money set aside for our daughters education in a 529 account. She was fortunate to receive a full ride (tuition and living expenses) for four years. Because she is so close to starting college her 529 funds are invested very conservatively (we only have one choice in our state and the older you get, the more conservative the investments are). I remember reading somewhere that we can withdraw the value of her scholarship. Can anyone confirm that? We would reinvest it in an UTMA or add it to her Roth and save the money to put towards graduate school.
I looked at this the other day and the rule seems to be that you can withdraw the amount of the scholarship without paying the 10% penalty (although you will have to pay regular income taxes), but the withdrawal must be in the same calendar year in which the scholarship is received. There may be additional complexities if you received any state tax benefits. You’ll need to confirm for your particular situation.
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I hope you know that you are not limited in 529 plan choices to just what your home state offers. Of course, state tax incentives may play a role in what your best choices are.
Generally, you can withdraw 529 money for any reason you want. The sricking point is whether or not earnings will be taxed and possibly assessed a 10% additional tax (“penalty”). One of the exceptions to when the 10% additional tax is assessed on the earnings portion of a non-qualified distribution is when the student has used tax-free scholarship money to pay for expenses. Whoever receives the non-qualified distribution in this case will still be assessed income tax on the earnings portion.
Read Chapter 8 of IRS pub 970; you should find it helpful.
The living expenses part of her scholarship is probably taxable. So check the rules on that. She might need to have some spare change available next April to pay the tax bill.
Can you tell me where the rule is that says that a 529 distribution based on a scholarship must be taken in the same calendar year that the scholarship was received in order to avoid the 10% penalty?
Edited to add: and why is the quote function no longer working??
(The problem with the codes has been brought up in the Re-launch thread, and Maine has tagged Sorin to look into it. Sorin started a new thread to investigate.)
@BelknapPoint , they just added a Quote button so I guess they disabled the old quote codes.
And as to the 529 question, I’ve also always understood that you don’t have to withdraw the money in the same year that the scholarship was received in order to avoid the tax. I think @tkoparent is mistaken.
So what I surmise is that I need to get the accountant involved to do it properly for our state. Darn - that guy gets enough money already !
I would like to know if the same year withdrawal thing is true as well, as I always thought that way, but can’t find anything now to back it up. My son will probably be Pell eligible at least the first two years and I’d like to avoid pulling the money out of the 529 using the scholarship exclusion for the penalty until he’s completely done. I doubt there will be anything left, but it would be nice to have the option of cashing in the entire 4 years worth of grants scholarships at the end instead of as we go.
You don’t have to get an account to do the withdrawal.
If grad school is in the future, why not leave it in the current account for another 4 years and see what she needs for that?
@twoinanddone The reason I would like to take it out is because the rate of return now is less than we could be getting in a 48 month CD. I would love for it to grow, even a little bit more, for her to use for grad school.
What plan is your 529 in that only allows one investment choice? That is extremely limiting and not at all user friendly.
@threebeans - Can’t you just roll it into another investment option? You can even roll it into another state’s plan if yours isn’t any good.
@BelknapPoint I agree and I don’t like it. We have only put into it what the max is for the state deduction and have quit contributing since she was awarded the scholarship from her college. Rather than roll it elsewhere I’d like to withdraw as we can without penalty and roll it into her other investments (i.e. Roth) so she can use it for a masters or maybe down payment on a house, etc. In my mind the money is there to help her launch and a home falls into what I intended it for.
What state are you in? Every 529 plan I have seen has multiple options so your perception that you only have one choice seems odd. If grad school is a possibility I would not take the money out, as mentioned you will still need to pay income tax on it.
Your 529 should give you options to switch to a more aggressive fund. Secondly, I would not take the money out as it’s one of the best investments to grow your money tax free, if used for college or grad school. Third, if you do withdraw it you are only taxed on the gains in the account, not on the principle.
Just remember, she has to have earned income to contribute to a Roth IRA.
Is she your only (or youngest) child? If not, you could always change the beneficiary to a different child. If she is, you could always just wait and eventually put it in a grandchild’s name. Never too early to start saving for college. Also, I agree that is sounds odd that you cannot change the investment. What Plan are you using?
My state allows 529 contributions to be tax deductible in the year made. I did make a nonqualified withdrawal one year in the amount of the scholarship, but the figuring out the taxes was such a headache I never did it again. So, I still have a little money sitting in an account for a kid who has no interest in grad school. Right now the plan is to just let it ride and hope there’s a grandchild someday?
You never know. When I completed my undergraduate degree, I was adamant that I would never go back to school. Sixteen years later, I found myself getting a professional degree (while not completley hating being a student in a classroom again). And letting it ride for a possible grandchild is always a valid option.
Just a note that if anything is by calendar year, it’s not necessarily same as academic year. Some scholarships may have the spring portion distributed in January of the next calendar year.