New GI Bill pays children's college



Dear Joe, We put some money away in a 529 plan for our daughter, but now we are planning to use the Post-9/11 GI Bill that will pay for almost all of her college expenses. Will this qualify for the scholarship exception, so that we can take penalty-free withdrawals from the 529 plan when she gets to college? --Barbara


Dear Barbara,

It appears the answer is yes. Any education benefits you receive under the Post-9/11 GI Bill will make you eligible for the scholarship exception. This means you will be able to take withdrawals from your 529 plan up to the amount of GI Bill education benefits received without incurring the usual 10 percent penalty tax on nonqualified withdrawals.

The 529 penalty exception applies to scholarships that are tax-free under Section 117 of the Internal Revenue Code, to benefits for U.S. military service under Chapters 30, 31, 32, 34 or 35 of Title 38, or Chapter 1606 of Title 10 of the U.S. Code, and to payments other than gifts or bequests for higher education which are excludable from gross income under any law of the United States.

Although the Post-9/11 GI Bill is found in Chapter 33 of the U.S. Code, which is not specifically mentioned, the payments made under the Post-9/11 GI Bill are excludable from gross income and therefore should be eligible under the third category of benefits.

Remember, just because the penalty is waived does not mean you avoid income tax on your 529 plan withdrawals. The funds withdrawn and not used for the beneficiary's qualified higher education expenses are treated as nonqualified withdrawals. The earnings portion of these withdrawals must be reported on either your or your daughter's federal income tax return, depending on who receives the withdrawal checks. If you live in a state with a personal income tax, check the rules of that state to determine if penalty-free scholarship withdrawals might also qualify as tax-free on the state level.

If you expect the total of your Post-9/11 GI Bill payments to be more than the balance in your 529 plan, you can consider making additional contributions to your 529 plan. Although the earnings will not be tax-free, they will be tax-deferred, and you may be able to shift the income to your daughter’s lower income-tax bracket during the withdrawal years. Depending on where you live, and which 529 plan you use, you might also be eligible to claim a state income tax deduction for your contributions. However, be sure to speak with your tax professional first.

Popular Questions


Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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