So You've Saved Money For Your Child's College Education In A 529 And They Get A Full Scholarship. Now What?

One question I hear quite often is in regards to 529 college savings plans. Concerned parents fear the consequences of saving money into these accounts and then finding themselves in a position where the child does not need the money either due to receiving a scholarship or decide not to attend altogether which could subject withdrawals of the money to not only taxes but a 10% penalty as well.

There is some good news that can reduce some of these fears. First, if your child is rewarded a scholarship and will not need the money the IRS does reward this by eliminating the 10% penalty. In this case the withdrawals would just be federally taxed on the earnings. In the end this ends up effectively turning the 529 into a regular taxable brokerage account, no harm no foul. You may also transfer the 529 beneficiary which would continue to defer any taxes or withdrawals until that beneficiary needed the money.

If your child ends up not attending college at all you are faced with fewer options. If you have another child you could simply transfer the beneficiary. If this is an only child you still have options. First, you could generally transfer the account to yourself or your spouse. Maybe you will feel like attending some higher education courses for work or when you retire. You could then continue to keep deferring the taxes.

What if you have no intentions of taking any more classes, your only child isn’t attending college and you can’t see any option but to take the penalty on the chin? The 529 plan can also be a great wealth transfer tool. Generally you can roll over 529 assets into another 529 plan from one generation to the next. So if you end up having grandchildren you could transfer the account all while retaining the tax deferment and potential tax-free withdrawals. Of course there are other issues to consider as far as gifting and possible estate tax implications when you begin to look at larger sums of money which is why you should always consult your tax advisor before making estate planning decisions.

Of course there is always the option of cashing out and paying the taxes and penalty. In many cases a 529 account will not be as large as a retirement savings so could make sense to just take the one-time hit and move on with your investment elsewhere to build it back up as quickly as possible. The bottom line is there are options available that could be in your favor, so don’t let the unknown stop you from setting up an account. Provided you are adaquately funding your own retirement these plans can provide some relief come time for college.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

3 comments
Jeremy
Jeremy

Lisa, you are absolutely correct. 529s, unlike other college savings vehicles (savings bonds for example) can use the proceeds towards virtually any higher education related expense. Whether it is books, lab fees, room and board, etc. So as you mentioned even if one were to receive a scholarship it is likely there would still be other qualified expenses that the funds could be used for.

You are also correct about the education not being required to be a full blown degree program. This could include just taking occasional classes at your community college or tech school as long as they are accredited. You couldn't fly down to Florida to take attend a real estate seminar, but most public schools will be accredited.

Thanks for bringing those items up.

Lisa Knight
Lisa Knight

Great article!

My understanding (which could be totally off base) is that the funds from a 529 can be used for any educational expense. I doubt that a college will give a full scholarship to include food, transportation, books, fees, supplies, etc. I know I had aid, scholarships
& savings but I still ended up taking out a loan to cover the extras that were left. Lab fees were outrageous & books, forget about it!

I also don't believe the funds have to be used for "college", just for further education. So if the child was going to tech school, couldn't the funds be used there?

frank
frank

Nice article. Thanks for posting that.