How to Avoid Tax Penalties on a 529

Amherst, NH Parent Has Questions

A 529 is a great way to save for education expenses.  Withdrawals are tax-free when used on qualified education expenses.  However, if the money is withdrawn for non-qualified expenses or if there is money left over to be withdrawn after all expenses are paid this is considered taxable income.  In addition to paying taxes on the leftover amount, you will also incur a 10% penalty for these withdrawals.

A parent in Amherst was anxious about saving for her daughter’s college education.  She knew that a 529 plan was a great way to do this but was concerned about incurring any future tax penalties.

Qualifying Expenses That Are Covered by a 529

College expenses can add up and a 529 is a great way to save for this.  Any withdrawals used for education are not taxed on a federal level.  The money in a 529 can be used to pay for tuition and fees associated with this, room and board, books and other school supplies, and computer costs.  You can also use up to $10,000 per year withdrawn from a 529 to cover tuition expenses for elementary, middle or high school.

Ensuring that All of Your 529 Withdrawals are Tax-Free

One thing that makes parents hesitant to put money into a 529 is the potential for a student to receive a scholarship.  While this will mean that you will be taxed on the money as you normally would, there is a scholarship exception for the 10% penalty.  You are able to make a non-qualified withdrawal in the amount of the scholarship.

For most 529 plans, you can change the beneficiary on the plan.  If you have another child that would be able to use the money that has accumulated, the plan can be switched to them.  You can also make yourself the beneficiary to return to school or pursue some continuing education.

It is important to note that a 529 plan covers not only under-graduate but graduate and further education pursuits.  Trade schools and other institutions can also be paid for using the money in a 529.

The Amherst resident was pleased to hear that the 529 plan offered plenty of flexibility and she now plans to begin saving immediately for her daughter’s education expenses.