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By using a 529 plan to save on your child’s college expenses, you can avoid college debt while meeting your educational goals. Saving on a 529 plan is generally easy, but accidentally withdrawing large sums of money from your account can result in an “unqualified” withdrawal.
If you find yourself withdrawing too much from your 529 account, there are several options available. However, it is important to act quickly as there are certain time limits that must be followed.
Redeploy surplus funds within 60 days
If you withdraw too much from your 529 account, you have 60 days from the first withdrawal to re-donate the funds. If you receive a refund from your school, such as if you dropped out of class, the resubmission period will be extended. At that point, he has 60 days from the refund date.
Please contact your plan provider for guidance on the process.
Use surplus funds for eligible educational expenses
If you overdrawn funds in January, you have until December 31st of the calendar year to spend the money on the applicable expenses. Eligible expenses include tuition, room, board, books, computers, software, etc. You may be surprised to learn what counts as a qualifying expense.
Figuring out how to spend money on eligible expenses is much more difficult in December, when you only have a few weeks to find eligible expenses. Or you can ask the university if they allow you to pay other eligible fees.
If you have any questions about eligible expenses, please consult with the university.
Roll over funds within 60 days
If you have another 529 account with the same or another beneficiary, you can choose to “roll over” the overdrawn amount to another account.
You have 60 days from the time of distribution to complete the rollover. Also, funds can be carried forward to his ABLE account, designed to support people with disabilities.
Pay taxes but avoid penalties
If you withdraw too much money from your 529 plan, you will be subject to income tax and a 10% penalty on your earnings for any amount not spent on eligible educational expenses.
For example, if you withdraw $10,000, but only had $9,000 in covered expenses, you’ve exceeded $1,000. You can calculate how much of that $1,000 he donated by comparing it to how much he earned in his account. If your account is 40% donations and the rest is earnings, you won $600.
That means $600 in tax plus a $60 fine.
If you use money in your 529 account for non-covered expenses, you’ll usually have to pay a 10% penalty, but according to the IRS, there are ways to avoid penalties.
These include situations where the beneficiary:
- Received a tax exempt scholarship
- died
- disabled
- Entered the U.S. Military Academy
- Paid for some or all of your education through a qualified employer program
- Using the money for eligible expenses that are also billed through the education tax credit
If any of these situations apply to you, TurboTax and other tax software can help you avoid this penalty. However, you can also work with your tax professional to ensure that everything is billed correctly.
Think Before Spending 529 Leftovers
529 If you have money left in your account. Whether you have money because your kids didn’t go to college, or you have money because you got a big scholarship, the 529 plan isn’t wasted. Also, there is no need to withdraw money immediately.
You can avoid taxes or a 529 fine by choosing one of the following options:
- Designate new beneficiaries (including yourself) for the remaining 529 funds. That money can be spent now or years down the road (perhaps when grandchildren go to college).
You may decide that none of these options are suitable for your purposes. But knowing the options available to you can help you make smarter decisions about when to pay taxes and when to avoid taxes.
Pay taxes and fines when all else fails
If none of the above options make sense, paying taxes and a 10% penalty on excess earnings may be your last resort.
In many cases, 529 accounts grow primarily through donations and less often through ‘earnings’ or market growth. You may be subject to taxes and a 10% penalty on relatively small earnings.
If so, it may be worth paying rather than bothering to re-donate funds or find a way to perfect yourself. It’s the last option you should have.