529 earnings used for qualified education expenses (includes room and board) are not subject to federal tax.
Roth IRA earnings used for qualified education expenses (does not include room and board) are subject to federal tax (assuming a non-qualified withdrawal).
Also, for those that do live in a state with a state income tax, many states provide a state tax benefit for 529 contributions.
Roths have an earnings limit too.
What do you mean? Are you trying to say there is an AGI limit which prevents higher income taxpayers from contributing directly* to a Roth IRA?
*try the indirect back door method
You can also transfer funds between 529 accounts. That can be handy if there is room for tax-free distributions in one account, but if those distributions came out, there wouldn’t be enough for tuition, room and board. I’ve had to keep an external record of transactions so that the funds mixed up to optimize taxes could be properly aligned with each of my daughters. The eldest is out of school, and she got a distribution equal to what her account value would have been if there had been no transfers. So the rest of what’s in both accounts is to benefit the younger daughter.
I started thinking about an aspect of fairness between daughters today. During all of my elder daughter’s time at school I was earning. Financial aid then was great, but now that I’m not working, the financial aid for my younger daughter is fan-damn-tastic! It’s not my elder daughter’s fault that I worked during her college years and am not working during my younger daughters college years. If I do nothing, the younger daughter will not only benefit from going to a state school (less expensive than the elder daughter’s private school), but also benefit from the more generous financial aid due to my not having a W2. I haven’t come up with a reasonable/logical way to make it more fair between siblings since financial aid is such a complicated black box. Just rambling off topic 
See http://www.irs.gov/publications/p970/ch08.html#en_US_2013_publink1000178534
So if the distribution is more than the AQEE for the year, you will have taxable distributed earnings.
@intparent, the OP is trying to spend the 529 money somehow. I don’t get the sense that he’s trying to spend the 529 money on himself. At worst, it will be spent on one of the grandkids.
So I don’t see anything wrong in what he is trying to do.
Do either of the DDs want to go to graduate school? Sounds like the money could be used for this or saved for the distant future.
Thanks MN. Grad school is a welcome idea! Switching the beneficiary to a (presumed to be produced) grand child is in the plans before paying tax on gains and paying a penalty. But in this uncertain world, I like the more near-tearm idea of using it for grad school. Although nothing in the realm of my daughters is guaranteed (!), greater than half time grad school might be on the horizon for the younger one. The elder one’s employer is giving her time off and free tuition toward earning credits for her masters, but less than half time. With respect to your handle here, the elder one is now considered a cheese-head (at least while she stays on her current rotation), so a “neighbor”. But I understand there’s sometimes a rivalry between your state and the one to your east?
He wants to take the money out, not spend it on a qualified expense, and still get the tax benefit. If he wants to “spend it on a grandchild” for their education, he should leave it in the account.
@intparent, are you reading the same posts that I’m reading?
It seems pretty clear to me that the OP is fine with spending the 529 on grad school or a grandkid.
Intparent, you are using the wrong tense. That’s what the OP wanted to do, found out he couldn’t and is moving on.
Now he is saying that. At the start of the thread, he wanted to take out the money and not pay the loans with it.
Yes, of course. That’s why people come here and ask questions, to find out if something is legal. He came here asking if he could take out 529 money now equivalent to expenses paid with loan funds in previous years. He’s been told no. Whether he would have used that money, were it permissible to withdraw it tax-free, to actually pay off the loans is irrelevant legally. If he wanted to keep his kid’s skin in the game, he could have used the money for whatever, again were it permissible to take the distribution tax-free.
You just have to have paid 529 QEE expenses in a year greater than or equal to 529 distributions in the same year. If part of those expenses were paid with loans, you don’t have to pay off the loans, you can just deposit the difference.
If you’re saying that, were it permissible, it’s not fair to the kid, that’s something else. I would disagree. IMO, considering the OP presumably made the contributions to the 529, it’s his money and, were it permissible tax-wise, he could have chosen to keep the kid’s ‘skin in the game’ rather than pay off the loans for the kid.
I had done some analysis before my elder daughter was was picking a school. Both daughters heard the same pitch. Based on the 529 balance, I figured they could choose “door number 1” which is to go to a private school and end up with loans (after getting the benefit of all of the 529 balance). They’d need to buy their own car. Or “door number 2”, which is go to a public school, have no loans to pay after graduation, and I’d buy them a car of their choice (no car payment).
My elder daughter chose door number 1. She got a check for the remaining $6K (to zero her 529 account), and now has loan payments and a car payment.
My younger daugher selected door number 2. My plan for when she graduates, is to pay off her loans and buy her a car. Any money left over that I can get out tax-free will go to her. Any money left over that I can’t get out tax-free will go to grandkids. My younger daughter and I agree that it’s “better out than in”, to quote Shrek, LOL! You can always put it back in, and that will reset the gains to zero. Since I wasn’t on the ball with respect to the rules, there will be some left in, but there will be enough pulled tax-free to pay off the loans and buy a car with cash.
Did any of them have scholarships? You are allowed to withdraw the amount equal to scholarships without penalty but it will be taxed.
Now for a related question. Can you withdraw 529 funds for scholarships/grants for past years or must you pull the money out in the tax year that the scholarship was disbursed?
Like the op, I also overfunded the 529 due to my daughter receiving unplanned scholarships. I don’t have an issue paying taxes but it would be nice to avoid the 10% penalty.
To the originally poster, you could always leave it there until you are in a lower tax bracket. I know that might never happen but it’s an option.
must match the year of the scholarship
Do you have an IRS citation for that? Here’s an article I found written by a 529 expert that isn’t quite as definitive (in fact, his opinion swings the other way):
http://www.bankrate.com/finance/college-finance/tax-code-squishy-on-529-plan-withdrawal.aspx
The article is from 2008, so maybe you have seen something newer from the IRS.
Lot’s of disclaimers in that link. I think his opinion is that the IRS should permit it and he gives his reasons why, but not that the IRS does permit it.
^^^
Oh, I agree. I’m just wondering what rgosula (or anyone else) might have seen that ends the speculation.
I don’t think there’s any worthwhile speculation, even in that article.