More than 40 percent of parents think that the money in a 529 college savings account is lost if it’s not used for college, according to a T. Rowe Price Family Financial Trade-Offs Survey.
That’s not true, but it may be one of the reasons more people aren’t saving in a 529 plan, a college savings fund that allows savings to grow free from federal taxes. Distributions are also tax free as long as they are used for qualified higher education expenses.
The same study — which was conducted in December 2014 and surveyed 2,000 parents — found that only about 31 percent of parents save in such a fund. A quarter of respondents said they were afraid they wouldn’t be able to access the funds at any time.
[Learn who can benefit from 529 plans.]
“That’s one of the misconceptions people have — or the concerns they have — we find when investing in a 529 account,” says George DuCasse, senior vice president at Ascensus College Savings, a 529 plan administrator that works with 33 plans across 18 states. “What happens if my child doesn’t go to college?”
Here are three factors to consider before withdrawing money from your college savings plan.
— Your can withdraw funds, but there is a penalty. If you need to take the money out for something other than college, you can, but any earnings will be taxed and there will be a 10 percent penalty on those earnings. The principal is not taxed, nor does the penalty apply to it.
Because the penalty is on the earnings, it’s not as punitive as it might sound.
For instance: If you contribute $5,000 and it earns $2,000, only the $2,000 is subject to taxes and penalty. If you are in the 25 percent tax bracket, that would be a loss of $700, leaving you with $6,300 to spend, still a gain on the initial investment, according to T. Rowe Price.
Bear in mind that college expenses are viewed broadly. Savings in 529 plans can be used at any institution eligible to participate in a U.S. Department of Education student aid program, which includes many trade schools and community colleges.
Qualified education expenses include not just tuition, but also room and board, books, mandatory supplies and computer equipment.
[Follow these five steps for utilizing 529 college savings plan funds.]
— You can take the money out penalty-free if your child gets a scholarship. If your child receives a scholarship, you can withdraw funds up to that award amount without having to pay the 10 percent penalty. However, you still need to pay taxes on the earnings.
Most experts agree you should withdraw the funds in the same year as your child uses the scholarship. So if you r child received the scholarship this September, you should withdraw the funds by Dec. 31.
However, if the student is still early in his or her college career, you may not know if there will be excess funds until graduat ion , says Dara Luber, senior manager, retirement for TD Ameritrade. When in doubt, Luber recommends checking with a financial advisor.
“Don’t forget, if they get a scholarship, they can still use 529 money to pay for qualified expenses, so things like room, board, books,” she says. “They can use it for other things, not just the actual tuition payment.”
DuCasse says it’s not that common to see withdrawals for scholarships. “Generally, scholarships aren’t full scholarships,” he says. “Even if you do get some degree of a scholarship, you still need a substantial amount of college savings on your own.”
[Read about how to set 529 plan spending with financial aid award letters.]
— There’s no time limit on using the funds. If you’ve saved in a 529 and your child decides not to go to college, you have a few options. For one, you can name another family member as the beneficiary. You could also save it for future generations.
Or, you could use the funds for yourself. “Maybe you want to go back to school after you retire — you can take the money and do that, as long as it’s an accredited, post secondary institution,” Luber says. “It’s got to be an eligible institution.”
Saving the money for graduate school is also an option. Excess funds can also be used for medical school, law school, master’s, doctoral and other professional degrees.
“There’s no time limit on it,” Luber says. “That’s what makes these a good way to save not only for your children but also for future generations, because college is getting more expensive for every generation.”
Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.
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3 Things to Know Before Cashing Out College Savings originally appeared on usnews.com
