Not sure if this was addressed before. can someone please give me some guidance on 529 withdrawal?
The tuition and fees per term are $16k. I get $10k as grant each semester and it gets credited to my term bill automatically, and I pay just $6K to the college for tuition & fee, after deducting the grant money.
Is it possible to withdraw $16K from 529 without any tax consequences? Or if I withdraw, $16K, will $10K be subject to tax?
I see that many says scholarship and grants are taxable. But, my confusion is this:
The school’s tuition bill is $16K, and I just used my grant towards it to reduce it to $6k. Doesn’t mean that $10K grant money is used for qualified education expenses? If so, why would it be subject to tax, if I withdraw it?
Also, please note that I don’t have room & boarding expenses because it is all virtual due to covid, so applying $10k to room& boarding is out of question.
When scholarships and grants are used for qualified expenses, as that term applies to scholarships and grants, they are not taxable. Tuition and some (but not all) fees are qualified expenses for scholarships and grants. You cannot take money from a 526 account to cover expenses that have already been paid by tax-advantaged funds, like a grant, without paying taxes on the earnings portion of the 529 distribution that equals the part of the expenses paid with the tax advantaged funds. Using your situation as an example, if you took $16k from the 529 account, $10k of that would be a non-qualified distribution, because that amount was already paid for using a tax-free grant. If at the time you took the non-qualified distribution 70% of your 529 account balance was contributions and 30% was earnings, $3k of the non-qualified distribution would be taxable because that amount represents the earnings portion of the non-qualified $10k distribution. Note that because a penalty exception applies, you would not also have to pay the 10% penalty for taking a non-qualified distribution. Clear as mud, right?
Thanks. This helps. One more question. Since I am doing all remote classes from parents home due to covid, will I be able to apply any of the grant money to room& boarding at home, As long as it is within the published COA for commuter students? If yes, how do I come up with a reasonable number?
I don’t know if this is a factor or not. I have always listed my parents address as the permanent home address though I lived in the on campus housing before covid. Would this matter in this?
If the school says you are at least a half-time student, room and board expenses even while living at home as a commuter student are 529 qualified expenses, up to the published COA numbers as provided by the school. The only reasonable number is the number that the school can give you for your current living arrangement. If you use grant money to pay room and board expenses, it will be taxable income to you. Room and board is a 529 qualified expense (as long as the school considers you at least a half-time student), but it is never a qualified expense to keep grants and scholarships tax-free.
Yes, both merit and need-based scholarships and grants can be used to take a proportionate 529 non-qualified distribution without incurring the 10% penalty. Where did you get the understanding that this only applies to merit scholarships?
(P.S. Merit scholarships are a kind of financial aid.)
Everything I’ve read used the word scholarship, which to me meant not need based. Glad to hear that folks getting need based aid can also withdraw without the penalty and only pay taxes on the gain.
The word “scholarships” does not mean exclusively merit awards. Lots of schools (at least in my experience) also apply that word to need-based aid. In this context, scholarship and grant are generally interchangeable.
Here is the IRS definition of the word “scholarship” as it relates to tax-free scholarships (found in IRS Pub 970, Tax Benefits for Education):
A scholarship is generally an amount paid or allowed to, or for the benefit of, a student (whether an undergraduate or a graduate) at an educational institution to aid in the pursuit of his or her studies.
No mention of including only merit awards or excluding need-based aid.
I am a bit confused. Lets say I withdraw $10K grant money from 529. And, university COA says $5k for Room & board for commuters. I thought I can apply $5k towards room & board, and would be liable for tax for the earning portion of the remaining $5k (which is about $1.5k). Are you saying that I am liable for the $10K?
What confuses me is this… In a normal situation with no scholarship, I will be able to withdraw from 529 for room & board expenses that I paid, with no tax liability. Why would it be different with Scholarship money withdrawn and a portion is applied to room & boarding?