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Are you a high school student wondering how to pay for college? If so, you may have heard of 529 plans—a tax-advantaged savings plan that can help you save for college. But what happens when you receive a scholarship? Can you still use your 529 plan to cover other expenses?
In this guide, we’ll explore the relationship between 529 plan withdrawals and scholarships. Let’s get started with 529 plan withdrawals and scholarships!
Understanding 529 Plans
A 529 plan is a special type of savings account that is designed to help people save money for college or other types of education after high school. It’s kind of like a piggy bank that you put money into over time, and the money can be used to pay for things like tuition, books, and housing when you go to college.
The cool thing about a 529 plan is that it has special tax benefits. That means you don’t have to pay taxes on the money you earn from the account, as long as you use it for education expenses. This can help you save more money in the long run!
Types of 529 Plans
There are two main types of 529 plans: prepaid tuition plans and college savings plans.
- Prepaid tuition plans: These plans allow you to prepay for tuition at a participating college or university at current prices, which can help you lock in a lower tuition rate. Prepaid tuition plans may also cover mandatory fees and room and board in some cases. However, prepaid tuition plans are usually limited to in-state public colleges and universities.
- College savings plans: These plans allow you to save money in a tax-advantaged account to pay for qualified education expenses at any eligible college or university in the country. College savings plans typically offer a range of investment options. The value of the account can fluctuate based on the performance of those investments.
It’s worth noting that each state has its own 529 plan, and some states offer both prepaid tuition plans and college savings plans. Thus, it’s important to research the different plans and their features before choosing one to ensure it fits your needs and financial goals.
Qualified Education Expenses
Qualifying education expenses are expenses that can be paid for with funds from a 529 plan without incurring taxes or penalties. Generally, qualifying education expenses include:
- Tuition and fees
- Room and board
- Books and supplies
- Computers and related equipment
- Special needs expenses
The Relationship between Scholarships and 529 Plans
When it comes to saving for college, many families use a 529 plan. Now, when a student receives a scholarship, the amount of the scholarship may reduce the amount of qualified education expenses that the student has.
For example, if a student’s tuition and fees are $20,000 and they receive a scholarship for $10,000, the remaining $10,000 can be paid for with funds from a 529 plan.
However, if the scholarship covers the full amount of qualified education expenses, there may not be any remaining expenses to be paid for with funds from a 529 plan.
In this case, you may be able to withdraw an amount equal to the scholarship from the 529 plan without penalty. However, you will have to pay taxes on the earnings portion of the withdrawal.
Non-Qualified 529 Plan Withdrawals
If you withdraw money from a 529 plan for non-qualified expenses, such as a new car or a vacation, you will have to pay both taxes and a penalty on the earnings portion of the withdrawal. The penalty is usually 10% of the earnings portion of the withdrawal, in addition to any federal and state taxes owed.
For example, let’s say you withdraw $10,000 from a 529 plan and $5,000 of that amount is earnings. You would have to pay taxes on the $5,000 earnings portion of the withdrawal, as well as a 10% penalty, which in this case would be $500.
Nevertheless, you will not have to pay taxes or penalties on the portion of the withdrawal that represents your original contributions to the 529 plan, only on the earnings portion.
So, in the same example, if you had contributed $8,000 of the $10,000 withdrawal and only $2,000 was earnings, you would only owe taxes and a penalty on the $2,000 earnings portion of the withdrawal.
Changing Beneficiaries
Suppose you have a 529 plan and you decide not to attend college or you receive a scholarship. In that case, you can change the beneficiary of your plan to another family member who is eligible to use the funds for qualified education expenses.
To do so, you will need to contact the plan administrator and follow their process for changing beneficiaries.
Typically, the process involves completing a beneficiary change form and providing some documentation to verify the new beneficiary’s relationship to the original beneficiary. This may include a birth certificate or other legal documentation.
The good news is that there are no tax consequences for changing beneficiaries within a family. This means that you can change the beneficiary of your plan without incurring any taxes or penalties, as long as the new beneficiary is a qualifying family member.
How 529 Plans Impact Financial Aid Eligibility
When it comes to financial aid eligibility, 529 plans are considered an asset of the account owner (usually your parent). This means that the value of the 529 plan will be factored into the Expected Family Contribution (EFC) calculation that determines your eligibility for need-based financial aid.
However, the impact on financial aid eligibility is generally lower for 529 plans than for other types of assets, such as savings accounts or investments held in your name. This is because 529 plans are considered a parental asset, which is assessed at a lower rate than your assets.
In addition, if you receive a scholarship, you can use the funds from the 529 plan to pay for other qualified education expenses without reducing the amount of financial aid you receive. This is because scholarships are considered as a resource that reduces your need, rather than as a dollar-for-dollar reduction in financial aid.
Frequently Asked Questions (FAQs)
Are you considering using a 529 plan to save for college, but worried about how it might impact your eligibility for scholarships and financial aid? You’re not alone! Many students and families have questions about 529 plan withdrawals and scholarships.
To help clear things up, we’ve compiled a list of some frequently asked questions on this topic.
How do scholarships affect 529 withdrawals?
Scholarships can affect 529 withdrawals in a couple of ways.
If you receive a scholarship, you may be able to use 529 plan funds for non-qualified expenses without penalty up to the amount of the scholarship.
This is because scholarships are considered to be a “qualified higher education expense” and are exempt from the 10% penalty typically applied to non-qualified withdrawals.
How do 529 plans affect scholarships?
529 plans can affect scholarships in a few different ways.
One potential impact is on your eligibility for need-based scholarships, as 529 plan assets are considered when determining financial need.
Additionally, using 529 plan funds to pay for qualified education expenses can reduce the amount of expenses you have to cover out of pocket, potentially reducing your financial need and affecting your eligibility for certain types of scholarships.
Do 529 withdrawals count as income?
In general, 529 plan withdrawals used for qualified education expenses are not considered taxable income for federal tax purposes. However, if the withdrawals are used for non-qualified expenses, the earnings portion of the withdrawal may be subject to federal income tax as well as a 10% penalty.
Do 529 plans hurt scholarships?
529 plans do not hurt scholarships. In fact, 529 plans can be used to pay for qualified education expenses. They can reduce the amount of expenses you have to cover out of pocket and potentially increase your eligibility for scholarships. However, 529 plans can impact your eligibility for need-based scholarships.
Can 529 plans pay for study abroad?
Yes, you can use 529 plans to pay for qualified education expenses related to studying abroad. This includes tuition and fees, books and supplies, and room and board. However, the expenses must be incurred by a qualified institution that is eligible for federal financial aid.
Additionally, some expenses related to travel and transportation may also be eligible if they are necessary for enrollment or attendance at the institution.
Bottom Line
In conclusion, 529 plans are a great way to save for education expenses, including college and study abroad programs. It’s important to remember that scholarships can impact 529 plan withdrawals. Nevertheless, it’s still possible to use the funds for qualifying education expenses.
By understanding the relationship between 529 plan withdrawals and scholarships, and seeking professional advice if needed, you can make the most of your educational savings and reach your academic goals.
