Some of the many reasons parents like 529 college savings plans are their tax advantages and flexibility. The Path2College 529 Plan offered by the state of Georgia allows Georgia taxpayers to contribute and deduct up to $2,000 each year on behalf of any beneficiary regardless of their annual income. The funds can be used for qualified educational expenses at any accredited post-secondary school in the United States. Qualified educational expenses include tuition, mandatory fees, books, supplies, and equipment required for enrollment or attendance; certain room and board costs, and certain expenses for “special needs” students.
So, what happens when you’ve been saving for years and your child receives a scholarship or decides not to attend college? Because a 529 plan has flexibility, account owners have multiple choices. First, you may decide to leave the funds in the plan, as the funds can be used for both graduate and post-graduate schools, community colleges, and certain proprietary and vocational schools. The beneficiary may need the funds later in his academic career. There is an overall maximum account balance limit of $235,000 for all accounts opened for a beneficiary.
If the beneficiary of a plan receives a scholarship, you can withdraw contributions and earnings up to the scholarship amount without a penalty. This is referred to as a “taxable withdrawal,” as both federal and state taxes will be due on the earnings portion of the withdrawal.
If you prefer to avoid a taxable event, you can change the beneficiary to another family member without penalty. “Family member” is broadly defined to include anyone related to the beneficiary as a brother, sister, parent, grandparent, son, daughter, aunt, uncle, niece, nephew, immediate in-laws or spouse of any of these persons. Half-siblings, stepchildren and stepparents also qualify.
As a last resort, you can withdraw the money as an “unqualified withdrawal.” Because the funds will not be used for qualified higher education expenses, the withdrawal does not meet the qualifications for favorable tax treatment. Generally, you can withdraw your contributions without tax implications, if you did not receive a state tax deduction for the contributions. If you received a deduction for the contribution, a ratio is used to determine the taxable portion of the contribution that has been withdrawn. The earnings portion for unqualified withdrawals is subject to state income tax, federal income tax, and a 10% penalty.
William G. Lako, Jr., CFP®, is a principal at Henssler Financial, and a co-host on Atlanta's longest running, most respected financial talk radio show "Money Talks" airing Sundays at 10 a.m. on Talk 920 AM, WGKA.