PREMIUM TOOLS

Savingforcollege.com

Exceptions to the withdrawal penalty
http://www.savingforcollege.com/articles/exceptions-to-the-withdrawal-penalty-990

Posted: 2016-11-01

by Brian Boswell

Financial Professional Content

Generally, when a 529 account owner receives a non-qualified distribution from a 529 plan they must pay an additional 10% tax penalty on the amount included in income. This is in additional to the normal tax the owner pays on earnings. But sometimes a non-qualified withdrawal is unavoidable, whether due to financial hardship or if a misfortune befalls the family. Knowing where a non-qualified withdrawal meets the criteria for a waiver of the early withdrawal penalty can help ease some of the financial burden.

Exception #1 – Beneficiary passes away or becomes disabled

If the beneficiary dies or becomes disabled before the funds can be used, normally the account would continue to function as intended with a contingent named successor beneficiary, assuming one was named on the account. The account owner can name another beneficiary and continue to let the account grow tax-deferred. If the account owner would like to withdraw the assets, however, they can make a non-qualified withdrawal, pay tax on the earnings, and avoid the 10% penalty tax.

In the case of death, the account owner may be asked to deliver a copy of the death certificate depending on the state and procedures of the plan provider. In the case of disability, the account owner must be able to prove that the beneficiary is unable to perform, "any substantial gainful activity because of his or her physical or mental condition" as determined by a physician.

Exception #2 – The beneficiary receives a scholarship(s)

If the beneficiary receives a tax-free scholarship or grant the account owner can withdraw up to the amount of the award without paying the additional 10% penalty. What this does is changes the 529 account from a tax-free investment, to a tax-deferred investment.

RELATED: Ask an expert: Can I use 529 plan funds to pay for college and get the American Opportunity Tax Credit?

Exception #3 – The beneficiary attends a U.S. military academy

If the designated beneficiary attends a U.S. military academy such as the USMA at West Point or USNA at Annapolis, the account owner may withdraw the assets penalty-free. However, the IRS has one caveat that, "the amount of the distribution doesn't exceed the costs attributable to such attendance." This would be the cost of tuition, fees, books, supplies, miscellaneous expenses, and – unlike qualified 529 withdrawals – transportation. If the account owner is considering taking advantage of this exemption, it might be a good idea to seek the counsel of a qualified tax professional.

Exception #4 – "Other" penalty-free scenarios

There are a few miscellaneous items that may allow a penalty exemption, including:

  • If the beneficiary received Veteran’s educational assistance. Any education funds received by the participant from a program administered by the Department of Veterans Affairs (VA) are tax-free and, therefore, the respective amount can be withdrawn without paying the additional penalty.
  • If the client received educational assistance through a qualifying employer program. In this case the client may be able to exclude up to $5,250 from the penalty.
  • "Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance." This is probably given by the IRS to allow for any future changes in the tax code where new programs may be introduced that would fit this description without having to rewrite the code.
  • If receiving the AOTC (American Opportunity Tax Credit) or Lifetime Learning Credit the account owner may withdraw up to the amount of the benefit without paying the additional penalty. Note that the account owner may not also claim the funds against an education expense. This is due to the "anti double-dipping rules."

RELATED: Avoid these 529 withdrawal traps

This information does not constitute tax advice and is provided for informational purposes only. Please consult your tax advisor, financial advisor, local taxing authority, and/or plan provider or sponsor for more information.

Financial Professional Content

Generally, when a 529 account owner receives a non-qualified distribution from a 529 plan they must pay an additional 10% tax penalty on the amount included in income. This is in additional to the normal tax the owner pays on earnings. But sometimes a non-qualified withdrawal is unavoidable, whether due to financial hardship or if a misfortune befalls the family. Knowing where a non-qualified withdrawal meets the criteria for a waiver of the early withdrawal penalty can help ease some of the financial burden.

Exception #1 – Beneficiary passes away or becomes disabled

If the beneficiary dies or becomes disabled before the funds can be used, normally the account would continue to function as intended with a contingent named successor beneficiary, assuming one was named on the account. The account owner can name another beneficiary and continue to let the account grow tax-deferred. If the account owner would like to withdraw the assets, however, they can make a non-qualified withdrawal, pay tax on the earnings, and avoid the 10% penalty tax.

In the case of death, the account owner may be asked to deliver a copy of the death certificate depending on the state and procedures of the plan provider. In the case of disability, the account owner must be able to prove that the beneficiary is unable to perform, "any substantial gainful activity because of his or her physical or mental condition" as determined by a physician.

Exception #2 – The beneficiary receives a scholarship(s)

If the beneficiary receives a tax-free scholarship or grant the account owner can withdraw up to the amount of the award without paying the additional 10% penalty. What this does is changes the 529 account from a tax-free investment, to a tax-deferred investment.

RELATED: Ask an expert: Can I use 529 plan funds to pay for college and get the American Opportunity Tax Credit?

Exception #3 – The beneficiary attends a U.S. military academy

If the designated beneficiary attends a U.S. military academy such as the USMA at West Point or USNA at Annapolis, the account owner may withdraw the assets penalty-free. However, the IRS has one caveat that, "the amount of the distribution doesn't exceed the costs attributable to such attendance." This would be the cost of tuition, fees, books, supplies, miscellaneous expenses, and – unlike qualified 529 withdrawals – transportation. If the account owner is considering taking advantage of this exemption, it might be a good idea to seek the counsel of a qualified tax professional.

Exception #4 – "Other" penalty-free scenarios

There are a few miscellaneous items that may allow a penalty exemption, including:

  • If the beneficiary received Veteran’s educational assistance. Any education funds received by the participant from a program administered by the Department of Veterans Affairs (VA) are tax-free and, therefore, the respective amount can be withdrawn without paying the additional penalty.
  • If the client received educational assistance through a qualifying employer program. In this case the client may be able to exclude up to $5,250 from the penalty.
  • "Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance." This is probably given by the IRS to allow for any future changes in the tax code where new programs may be introduced that would fit this description without having to rewrite the code.
  • If receiving the AOTC (American Opportunity Tax Credit) or Lifetime Learning Credit the account owner may withdraw up to the amount of the benefit without paying the additional penalty. Note that the account owner may not also claim the funds against an education expense. This is due to the "anti double-dipping rules."

RELATED: Avoid these 529 withdrawal traps

This information does not constitute tax advice and is provided for informational purposes only. Please consult your tax advisor, financial advisor, local taxing authority, and/or plan provider or sponsor for more information.

Access exclusive tools and resources for professionals only

Access our exclusive content, reports, calculators and sales leads with a Premium Subscription.

Free for Ameriprise Financial, Commonwealth Financial, Morgan Stanley, Raymond James and RW Baird.

Ameriprise Financial instructions

Consult with your office/branch manager for instructions.

Commonwealth Financial instructions

Commonwealth Financial Advisors, you will find your Savingsforcollege.com portal on CommunityLink in the Financial Planning Playbook under Education Planning Tools.

LPL Financial instructions

Visit the Education Planning page in the LPL BranchNet Resource Center to access your Savingforcollege.com portal.

Morgan Stanley instructions

Visit Tools and Forms in the Education Savings Products page in 3DResources to access your Savingforcollege.com portal.

Raymond James instructions

Visit the 529 Plan Resource Center on RJ Net to access your Savingforcollege.com portal.

RW Baird instructions

Visit the 529 Department page on BairdWeb to access your Savingforcollege.com portal.

 

Reset email successfully sent.
Please check your inbox.

Close
page loadtime mark

Advertisement


close