529 Plans: The Impact of Scholarships

By Marc Shaffer

Congratulations! Your child has received a scholarship and now you’re probably wondering how this will factor into your 529 Plan.

A 529 Plan Account offers tax-free earnings and tax-free withdrawals, as long as the money is used to pay for qualified educational expenses. For an overview of what is and is not considered a qualifying expense, visit our blog: Qualified and Non-Qualified Expenses of a 529 Plan

So, can you withdraw the scholarship amount out of your 529 Plan without penalty?

According to SavingforCollege, “If you process non-qualified withdrawals, you’ll incur income tax as well as a 10% penalty but only on the earnings portion of the withdrawal. Since contributions are made with after-tax money, they will never be taxed or penalized. You can always use the money leftover in the 529 Plan Account for graduate school, continuing education or a future grandchild’s education.”

However, a scholarship is one of the few exceptions to the 10% penalty rule. The others would include if the beneficiary became incapacitated or if they attend a U.S. Military Academy.

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. Assuming you are less interested in the tax-free growth for the alternative suggestions for the excess 529 Plan Account balances and you are comfortable paying the income tax on the withdrawal over and above the “cost basis,” it may make sense to consider withdrawing the money, paying any tax due as a result and to then using the net amount to expedite meeting other goals.

If you have any questions about this topic or anything related to 529 Plans and college savings, please let us know!



Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this content, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for you or your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Searcy Financial Services, Inc.

The content of this letter does not constitute a tax or legal opinion. Always consult with a competent professional service provider for advice on tax or legal matters specific to your situation. To the extent that a reader has any questions regarding the applicability of any specific issue discussed in this content, he/she is encouraged to consult with the professional advisor of his/her choosing.  

Published for the blog on September 27, 2021 by Searcy Financial Services, your Overland Park, Kansas Fee-Only Financial Planner and Investment Manager.