529 Plan and College Savings

Archive for December, 2008

Question: What are the drawbacks to a 529 College Savings plan?

I’m considering opening up a 529 college savings plan for my son. I’ve read about the benefits and the different state plans. What is hidden is what if my son decides NOT to go to college? What happens then?

Do I get to keep the money? Do I have to pay taxes and what kind of penalties are there when I take the money back for myself? On the several financial sites I’ve found, they just mention that there may be penalties involved.

Answer: Kevin

There is nothing hidden if your son opts to not go to college. The money is available. You would be making a nonqualified withdrawal and the earnings component of that withdrawal is taxed and subject to a 10% penalty (see pp. 49-51 of IRS Publication 970). Alternately, you can change the beneficiary to somebody else in the family (again, see IRS Pub. 970 for who qualifies).

There are a few bits of misinformation in some of the earlier responses.
There is no federal age limit – although a couple of plans had set age limits. I am not sure if they still apply. Check any plan’s disclosure documents for such restrictions. Even if you are in a plan with such a restriction, you can rollover taxfree to another plan without such a restriction when the beneficiary approaches the age.

Penalty applies not to the money withdrawn, but only on the earnings component.

The sunset provision of the 2001 tax bill will not mean that 529’s will be eliminated. Rather, sunsetting would mean that tax status of the 529s reverts back to pre2001 conditions. Prior to 2001, earnings were taxed at the beneficiary’s rate – the combination of tax-deferred growth and lowered tax rate would still make them of interest to many families. But I think it is a matter of when and not if, the Congress extends 529 taxfree status. There are too many interested parties – from voting constituents to donating corporations – to allow the tax status to revert.

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