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If your children don’t need the money you’ve saved, there’s actually a simple way to avoid the 529 withdrawal penalty.

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Question: I have a 529 college savings plan for my son with $56,000 in it. My son has won a full scholarship to college valued over $150,000. I’m trying to find out what I need to do to withdraw the 529 money without any penalty.

Mike Y. in Pennsylvania 

Andrew Pentis, personal finance expert and certified student loan counselor at Student Loan Hero, responds…

Dear Mike,

First off, congratulations are in order, as scoring a full-ride college scholarship is no easy feat.

And in this day in age, avoiding federal and private student loans — plus calling off the search for student loan forgiveness — is a huge win for your whole family.

As happy as you must be for your son, it’s also fair to be concerned with how to handle that five-figure savings balance. After all, you won’t employ it in the way you once imagined.

Thankfully, there’s a rather simple (and likely satisfying) answer to your question: The IRS allows you to withdraw an amount equal to your son’s scholarship award without facing the 10 percent penalty attached to other atypical, non-qualifying withdrawals.

Now, before you call your 529 plan account manager and ask to cash out, Mike, keep these two facts in mind:

Uncle Sam will want a cut

Unlike with more traditional qualifying expenses, you’ll still have to pay federal (and potentially state) income tax on a withdrawal related to your son’s scholarship. We recommend talking to a certified tax attorney to determine what taxes you will need to pay, as well as when and how, so you can ensure you file your taxes correctly with those withdrawals included.

Make that withdrawals, plural

First, you must wait until your son officially receives his tuition reduction to make any withdrawal. After he’s handed about $37,500 of school-offered financial aid for his freshman year, for example, you can take out that amount — or $18,750 per semester, depending on the school’s billing quirks — but not a cent more.

Given the rough dollars-and-cents figures you provided in your question, you’d probably have to wait until at least your son’s third semester on campus to zero out your 529 account balance. That would allow you to fully avoid the 10 percent 529 withdrawal penalty you’d face otherwise. Attempting to pull out the entire $56,000 before your son actually receives that amount of aid would be considered a nonqualified withdrawal. Thus it would be subject to the very same 10 percent penalty you’re attempting to avoid.

If you don’t like the strings attached to your unusual but qualifying withdrawal, you could also keep your 529 plan savings right where it is. Even if you’re done making contributions, you have other account management options, including:

Covering expenses that the scholarship doesn’t

If your son’s scholarship won’t completely pay for secondary qualifying expenses, you could make tax- and penalty-free withdrawals from your 529 account to finance them. This could include things like books, school supplies, and computer equipment. Unfortunately, Mike, not all full rides are truly full, and your savings could still come in handy.

Another family member could use the funds

 If your son has a sibling, or if you have another family member with (upcoming) education costs, you could change the account beneficiary. If you’re feeling extraordinarily generous, you could keep the 529 where it is, allow it to grow and eventually gift it to a grandchild. Perhaps your son’s offspring could eventually benefit from your hard-earned savings.

When you have $56,000 sitting in your college savings plan, “hard-earned” is exactly what it is. You likely stashed away hundreds of dollars every month, throwing in a little extra here and there, with the idea that you’d help your son foot the bill for college.

Now that you don’t need the savings for that specific purpose, hopefully, the IRS’ generous rules allow you to put it toward another worthy cause.

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About the Author

Andrew Pentis

Andrew Pentis

Andrew covers personal finance expert with a focus in student loans for Student Loan Hero. His work has appeared in 30-plus publications. He is interested in creating actionable content.

Published by Debt.com, LLC