The truth about scholarships and 529 plans

Kathryn FlynnBy: Kathryn FlynnBy: | 

Despite their numerous benefits, many parents hesitate to enroll in a 529 plan because they're not sure what the future holds for their child. One of the most common questions we hear at is "What happens to my 529 if my child gets a scholarship?"

A scholarship, unlike a student loan, is money awarded for college that doesn't need to be paid back. Scholarships can help fill the gap when a family isn't able to save for their entire college bill, and they can put a coveted, more expensive school within reach. But just because you feel your child has a good shot at winning a scholarship one day doesn't mean you should hold off on saving with a 529. Here's why:

1. You'll never lose all of your savings.

A 529 plan offers tax-free earnings and tax-free withdrawals as long as the money is used to pay for qualified education expenses. If you end up taking a non-qualified withdrawal, you'll incur income tax as well as a 10% penalty - but only on the earnings portion of the withdrawal. Since your contributions were made with after-tax money, they will never be taxed or penalized.

Find your 529 plan - Select your state below

Did you know that residents are not limited to investing in their own state's plan? Another state may offer a plan that performs better and has lower fees. Select your state below to see your state's plan and other options.

Find a 529 plan in

Select your state below


Find a 529 Plan. Select your state below.

Did you know that residents are not limited to investing in their own state’s plan? Another state may offer a plan that performs better and has lower fees. Select your state below to see your state’s plan and other options.

2. You can avoid the penalty if you get a college scholarship.

There are a few special exceptions to the 10% penalty rule, including when the beneficiary becomes incapacitated, attends a U.S. Military Academy or gets a scholarship. In the case of a scholarship, non-qualified withdrawals up to the amount of the tax-free scholarship can be taken out penalty-free, but you'll have to pay income tax on the earnings. As founder Joe Hurley likes to say, "the scholarships have turned your tax-free 529 investment into a tax-deferred 529 investment".

3. You can change the beneficiary to another family member.

If you don't want to pay any taxes when you withdraw (and why would you?), you also have the option of changing the account beneficiary to another qualifying family member. A younger sibling would be the obvious choice, but you can also change the beneficiary to a parent, grandparent, niece or nephew without tax consequences. Beginning January 1, 2018, 529 plans can also be used to pay for tuition at private elementary and high schools.

4. You can hold on to your savings.

Unlike other college savings vehicles, such as Coverdell Education Savings Accounts, there's no time limit on 529 savings plans - which means you can let your savings grow in your account until you have a use for them. Your child who earned a scholarship may very well continue on to graduate school and might need some help paying for it. In fact, according to the New America Foundation, the median combined student loan balance for those who earned a graduate degree in 2012 was $57,600. Every penny paid for with the 529 account will reduce your child's potential debt burden.

Another option is to use your savings to continue your own education. 529 plans can be used to pay for courses at any eligible institution, including community colleges and vocational schools. Whether you're looking for a career change or taking up a new hobby, simply make yourself the beneficiary of the 529 plan and you'll be able to start taking tax-free withdrawals to pay for your courses.

5. You can use a 529 plan to pay for more than just college tuition.

For example, let's say your child wins a full-tuition scholarship that pays for tuition and fees to attend Duke University. In this case you might still be able to take a tax-free withdrawal from your 529 plan, since qualified higher education expenses under Internal Revenue Code Section 529 include books, required supplies and equipment and some room and board. For students attending Duke this year, these costs totaled just over $18,000.

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Kathryn Flynn

Kathryn Flynn

Content Director

Kathryn is Content Director at She has been quoted in financial publications including the Wall Street Journal, the NY Times, Fortune, Money and GOBankingRates, and has been an expert guest on personal finance podcasts. Prior to, Kathryn worked in product marketing at Henderson Global Investors (now Janus Henderson Investors), a global asset manager. She earned her MBA with Finance Concentration from DePaul University's Kellstadt Graduate School of Business, and has prior FINRA Series 7 and 63 licenses. Kathryn has 529 college savings plans for each of her three children, and enjoys creating content to help other families prepare for future higher education costs.