That sounds a bit over the top, I know.
And no, I’m not talking about raiding the little ceramic piggybank either.
But some parents and grandparents who are struggling in this economy are finding the need to tap into their retirement accounts (worst case scenario) and even backing money out of 529 plans they set up for their child or grandchild, just to make it through these tough times.
These stories are still exceptions to the rule. However, some thought is essential as to how and why to liquidate a 529 Plan that is not being used for qualified higher education expenses.
Consider some 529 Plan basics
529 accounts are considered Parent Assets which may be assessed in the financial aid formulas up to a maximum 5.64% after allowances.
Also, 529 Plans are trying to keep up with the times by offering investors more flexibility to stay agile in the ever-changing markets.
Distributions from 529 Plans are tax-free when used for qualified higher education expenses. Joseph Hurley’s web site Saving for College is one of the best resources for families to learn all about 529 Plans.
- Qualified withdrawals include money for tuition, books, room and board, etc. If a computer is required by all students at a college, then the computer may also be considered a qualified expense.
- Computer purchases were qualified expenses up to 2010 but then the caveat expired. Congress may reinstate that expense in 2012 and make it retroactive for 2011, but there are no guarantees.
- You may NOT take loans against your 529 account.
- Withdrawals for non-qualified expenses may incur federal income tax and a 10% federal penalty tax.
So what happens when the financial constraints of “life” get in the way of planning for college?
A worried grandparent who has suddenly realized the gift they gave their grandchild in the 529 Plan is going to force them to become a financial burden on their offspring (i.e. unexpected medical bills) may need to withdraw the funds for themselves.
The benefit of the 529 Plan is that this type of transaction can take place, albeit with a 10% penalty and tax due on any earnings. The bottom line is that the plans are flexible.
Another question I have had a parent ask is: “What if my student is offered a scholarship, and doesn’t need all of the money we’ve set aside? Then what?”
Well, a family can withdraw up to the scholarship amount, penalty free. They may be subject to tax on the earnings, however. Or, the family can change the beneficiary.
Parents and grandparents who have been able to save for college are finding themselves in a better position to help their student pay for school than those who did not. The 529 Plan is not a big factor in the financial aid formulas so saving does not “hurt” a student’s prospects for need-based financial aid the way many might think.
To learn more about how a 529 Plan fits into the entire college planning process, take a free look at our member site. Families can learn how the “money works” and why it is an integral component of the college selection process.
{ 2 comments… read them below or add one }
Regarding the taxes and penalties on the non-qualified 529 withdrawals, are they on the entire withdrawal or just on earnings from the account? Since there’s no deduction for the contributions/deposits, is the entire non-qualified distribution taxed and penalized, or just the portion of it that represents the investment gains? Just look for clarification. I hate “tax stuff”! Thanks.
Paul, Great question! The principal is not taxed again – recall that contributions to 529 accounts are done with after-tax money.
The earnings portion of a non-qualified withdrawal will be subject to federal income taxes at the Distributee’s rate (usually the parents, or owner of the account) as well as a 10% federal penalty assessment.
If the money is being withdrawn because a student doesn’t need it (i.e. a scholarship covers costs, or they don’t go to college at all) then an alternative to some families might simply be to change the beneficiary. You can change the beneficiary on your 529 Plan account to eligible family members of the original beneficiary without incurring federal income tax and the 10% federal penalty tax.