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What is the penalty on an unused 529 plan?Updated: 2015-01-02
Table of Contents
- What is a 529 plan?
- Are 529 plans only for my state's public colleges?
- Name the top 7 benefits of 529 plans
- Does a 529 plan affect financial aid?
- What is the penalty on an unused 529 plan?
- Are there gift & estate tax benefits for 529 plans?
- Can I have 529 plans from multiple states?
- Which is the best 529 plan available?
- What are the top-performing 529 plans?
Only the earnings portion of a non-qualified withdrawal is subject to a 10% withdrawal penalty
- Distributions are allocated between principal and earnings on a pro-rata basis.
- That means that your withdrawal is divided into contribution and earnings based on the following formula:
- Account Contributions / Account Value x Distribution = Contribution Portion.
- Your contributions (the amount you originally deposited) will never incur penalty.
What are the exceptions to the penalty rule?
- If the beneficiary dies or becomes disabled
- If the student decides to attend a U.S. Military Academy
- If the student receives a scholarship
- In all of these cases the earnings portion of the withdrawal will incur income tax.
All earnings on non-qualified distributions will be subject to tax as ordinary income at your tax rate
- Non-qualified withdrawals will transform your 529 plan into a taxable investment.
- However, some 529 plans allow you to direct the withdrawal to the beneficiary, which would presumably keep it in a low tax bracket.
- In addition, if you were able to deduct your original contributions on your state income tax return, you will generally have to report additional state "recapture" income.
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So what is a non-qualified withdrawal?
- Qualified withdrawals include:
- Tuition and fees
- Equipment required for course enrollment (including special needs equipment)
- Some room and board expenses
- Non-qualified withdrawals include:
- Transportation costs
- Computers (unless the school requires them)
- Student loan repayments
RELATED: Top 5 ways to spend 529 savings
What if I have excess funds? How do I minimize the penalty?
- Change the beneficiary to another qualifying family member who is planning go to college
- Hold the funds in the account in case the beneficiary wants to attend grad school later
- Make yourself the beneficiary and further your own education
RELATED: Avoid these 529 withdrawal traps