After 4 successful college years my son graduated a few weeks ago with a STEM degree. During his 4 college years he received the New York State (NYS) STEM scholarship for tuition. He is now considering an employment offer in a STEM field out side of NYS. This means he would need to pay back the past 4 years of STEM award – a total of about $28,000.
My wife and I began a 529 plan for him and his siblings many years ago. There is enough residual $$ in that plan to pay back the STEM. My question: Is there a method to withdraw the 529$$ without paying the taxes and penalties if I can document that the money was used to repay the past 4 years of the STEM award?
Note had son rejected STEM over the past 4 years and used his 529$ to pay tuition - the money would have been withdrawn without taxes and penalty. So, by my son taking the STEM and now having to pay it back, we may actually be punished to the tune of income taxes and 10% with-drawl penalty. Doesn’t seem quite fair … does it?
The other option of course is to leave the $$ in the 529 account should he or a future child of his decide to go on in college.
You can’t use 529 money to pay back student loans, so I imagine it would be the same in this situation. The taxes and 10% penalty are only on the gains, so maybe tapping it in a non-qualified withdrawal would not be as bad as you fear?
No. You may be able to avoid taxes and penalties on a 529 distribution that is taken in 2019 and used to reimburse qualified expenses that were paid in 2019. And you may be able to avoid the penalties on a 529 distribution that is taken to offset the STEM scholarships from previous years that paid for qualified expenses, but I don’t see any way to avoid the taxes on that distribution. See chapter 8 of IRS pub 970 to learn when exceptions to the 529 10% additional tax (“penalty”) can be applicable (that information is near the end of the chapter).
That’s how the rules for both the STEM scholarship and 529 accounts are written. You and your son must have known what the consequences would be if he took employment outside of New York State after taking advantage of New York’s STEM scholarship. Choices, choices…
Thumper, Belknap, cshell:
Thank you all for your replies. You have all pretty much confirmed what I already knew / suspected based on the literature and materials I was able to find. I was hopeful there was another piece of legislation some place that I had not discovered — allowing for me to repay STEM from 529 plan without penalty and taxation.
I think part of the issue here is that the NYS STEM award is state administered - whereas the 529 are IIRC regulated (Federal). The result is that the plans don’t compliment each other and the student / parents have to accurately predict the future to get the best financial outcome.
The good news anyway is that our governments do see the value of education in the population - and have some plans in place to (minimally) help reduce the cost of education.
Doesn’t sound like you have to pay the penalties. The scholarship was used for tuition. So you can withdraw that amount from the 529 without penalty, just paying the taxes on earnings. That’s probably a good deal since earnings may be only one third to one half of the value of the account.
I think you have to watch the timing of the withdrawal too. 529 plans allow you to withdraw an amount without penalty if the student received a scholarship for college. The STEM scholarship is a scholarship UNTIL it becomes a loan.
