• filter:

Is the 10% penalty on 529 plans on the entire withdrawal amount, or only the gain?

  • Page :
  • 1
  • Text Only
  • Search this Topic »
Voting History
rated:
I've put about 15k into my son's 529 plan. The account has increased in value and the current balance is at 28k. I plan to withdraw about 5k for unforeseen medical expenses. Will I be hit with the 10% penalty?

Member Summary
Staff Summary
Thanks for visiting FatWallet.com. Join for free to remove this ad.

rated:
http://lmgtfy.com/?q=529+withdrawal+penalty

First result in the first 2 bullets clearly explains its on earnings and is prorated based on earnings to principle ratio.

rated:
Is college in the son's future if all works out well?

Even if you take money out for medical bills or other necessary expenses, you're still making a nonqualified withdrawal.
One reason not to make this type of withdrawal is to avoid depleting your college fund at a time many funds are doing well.. Another compelling reason is that these withdrawals don't enjoy tax-favored treatment. The earnings part of a nonqualified withdrawal will be subject to federal income tax, and the tax will typically be assessed at the account owner's rate, not at the beneficiary's rate. Plus, the earnings part of a nonqualified withdrawal will be subject to a 10 percent federal penalty, and possibly a state penalty too.

That said,  will there be an income stream in the family?  IF so, consider a new credit card at 0% APR rate for 14 to 21 months depending on the card you get.    Monthly payments are modest for now.  IF you still have a large balance at the end of that time, you may be able to get another 0% rate balance transfer with related fees at 5% or less.  Usually less..  Avoid the 10% tax penalty and taxes for now.

rated:
It's something that does NOT work like withdrawal from a Roth IRA where you can specify that you're taking money only from contributions and avoid tax and penalties.

So a 10% penalty will be assessed on earnings only. With $15k contribution +$13k earnings, 46% of the balance are earnings. So on the $5k withdrawal, you will be assessed 10% penalty on 46% of $5k which is ~$2300 so you will have to pay $230 penalty in your next tax return. That's on top of these same $2300 earnings also being taxed as ordinary income so assuming you're in the 25% bracket, you'll be taxed another $580 (25% of $2300). In this case, total tax on the $5k withdrawal would be over $800 unfortunately.

Depending on your ability to repay the $5k quickly, I'd put that in perspective with other financing options definitely that may not cost you quite as much like an HELOC.

rated:
Also, if you get a state tax credit, I think most states require that you forfeit that.

rated:
Dus10 said:   Also, if you get a state tax credit, I think most states require that you forfeit that.
I have not thought about that but if true, that'd be a mess to sort out. How would they figure out the amount of credits or deductions on your state tax that would be clawed back?

rated:
Shandril said:   
Dus10 said:   Also, if you get a state tax credit, I think most states require that you forfeit that.
I have not thought about that but if true, that'd be a mess to sort out. How would they figure out the amount of credits or deductions on your state tax that would be clawed back?

  Yeah, I have not had to deal with it... but it seems like a real headache.  If they didn't do it, however, the state tax credits would be able to largely [or entirely] offset the 10% penalty, depending on how much is principal and how much is earnings.

rated:
They prorate the withdrawal into principal vs earnings, and if the state recaptures it, it should be at your tax rate at that time. So if you were in a higher state bracket, and then withdrew while in a lower one, you still got a bit of a deduction. If something happens to the market and your income, there may not be much gains to worry about, and therefore no 10% penalty when you go to withdraw. If you enroll in community college half-time for cheap, it could make sense to do that, and withdraw up to your cost of attendance from the 529. Not sure if you want to switch the beneficiary to yourself first (likely-and you should be able to switch back). You may even be able to get student loans to cover the school costs as well, yet still withdraw 'qualified' from the 529. Depending on when you incurred the bills, you can probably wait a few months or get on a plan and wait for a 2nd semester to do this as well, but for 5k it is probably enough to just do a semester. But, it sounds like you're looking at saving 250 in penalties (on the 2500 in gains) by doing this, plus a bit of state tax at your marginal rate for 5k this year- so it may not be worth doing this for such a small amount when the community college will cost more than that.

rated:
Most states are doing tax credits, so it wouldn't need to be based on tax rate unless there are phaseouts. For instance, here it is a 20% tax credit on deposits up to $5k, so up to a $1k credit. So if you withdraw $100 of your deposit (regardless of the earnings), you would be required to payback $20 worth of credit.

  • Quick Reply:  Have something quick to contribute? Just reply below and you're done! hide Quick Reply
     
    Click here for full-featured reply.


Disclaimer: By providing links to other sites, FatWallet.com does not guarantee, approve or endorse the information or products available at these sites, nor does a link indicate any association with or endorsement by the linked site to FatWallet.com.

Thanks for visiting FatWallet.com. Join for free to remove this ad.

While FatWallet makes every effort to post correct information, offers are subject to change without notice.
Some exclusions may apply based upon merchant policies.
© 1999-2017