A 529 Plan is an education savings plan designed to allow families to set aside funds for future college costs, while allowing these funds to grow tax-deferred and distributions to pay for the beneficiary’s college costs to be withdrawn federally tax-free. But, what happens when the beneficiary receives a college tuition scholarship?
Typically, one would be responsible for income taxes and a 10% penalty on the earnings portion of the 529 withdrawals that are not used for qualified education expenses. However, there is an exception for tax-free scholarships.
You can withdraw up to the amount of the scholarship without being responsible for the 10% penalty but you will still be responsible to pay ordinary income taxes on the earnings.
As most 529 Plans allow you the option of making withdrawals payable to the owner, the beneficiary or the school, Joe Hurley of SavingForCollege.com suggests that when taking a scholarship withdrawal, the money and the 1099 form reporting the withdrawal be sent to the student, who is likely in a lower income tax bracket than the owner of the plan.
Remember that you may use these funds for graduate school expenses or you may switch the beneficiary of the 529 Plan to another family member for their respective college expenses.
Todd C. Ratner, Esq.
Photo Credit: Microsoft