The 529 Plan Scholarship Exception

If you were fortunate enough to be able to save money to pay for your child’s college education AND they ended up receiving scholarships to put toward that education, you may be wondering what to do with that excess cash in your 529 account. Luckily for you, there are some special rules pertaining to scholarships that may apply and save you from paying additional tax.

Typically, you would owe income taxes and a 10% penalty on distributions that are not used for qualified education expenses, however, you may withdraw money up to the amount of the scholarship that your child received and only pay tax on the earnings that your original investment made.

Here are some additional alternatives for handling your excess funds:

  • Pay for qualified expenses other than tuition (room and board, books, and other mandatory fees).
  • If your child ends up pursuing further education, like graduate school for example, you can put the funds toward that tuition.
  • Switch the beneficiary of the account to another family member who can use the funds toward their college education in the future.

Be sure to consult your tax preparer or 529 plan administrator for additional tax planning tips related to your 529 plan.