What Happens to Your College Savings Plan When You Receive a Scholarship?

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You’ve been saving for your child’s college expenses since she was just a baby. You’ve carefully budgeted and run the numbers for how much college will cost in 18 years. You were on track and prepared to give your only child the gift of a college degree, debt free. Then, you learn that your daughter has earned a full-ride scholarship to her dream school! You’re so proud and happy for her! Amidst the celebrations, you wonder: what will happen to all the money I have saved for her college expenses now that she doesn’t need it?

The first thing to consider is how much of your child’s college costs are being covered by the scholarship. Perhaps it is just covering tuition and fees, leaving room and board up to you. A 529 plan will allow penalty- and tax-free withdrawals for all Qualified Higher Education Expenses incurred. Qualified higher education expenses include:

Once you’ve determined what costs are remaining after the scholarship, use your 529 plan to fill the gaps as much as you can. If you still have funds remaining after that, you have several options.

Graduate School Expenses

You could save the funds for post-graduate education. Many states’ 529 plans do not have a time limit to withdraw funds, meaning you could keep the plan open and funded indefinitely until you decide how you want to use it. Virginia 529 plans, however, do impose a time limit on distributions. You must use the funds within 30 years from when the beneficiary graduates from high school (usually age 48-49), or 30 years from when the account was opened, whichever is greater. Even with that restriction, that still leaves plenty of time to decide how the funds should be used.

Change Beneficiary

You can change the beneficiary. The new beneficiary must be related to the original beneficiary, whether it’s their sibling, parent, or even their child. (Remember you have up to 30 years to decide where these funds are going.) Maybe your child doesn’t want to pursue higher education, but this could be the perfect opportunity for you to go back and get that master’s degree you put off when you had your child. Simply change the beneficiary to yourself, and you are free to use the funds tax-free for your own education.

Taxable Withdraw

Finally, if none of those options work for your situation, you can withdraw the equivalent amount of the scholarship. Normally, a withdrawal that is not for a Qualified Higher Education Expense would have a 10% penalty imposed and the earnings portion of the distribution would be taxable. However, the 10% penalty is waived for withdrawals of the same amount as the scholarship. You will still have to pay income tax on the earnings portion of your withdrawal, but at that point you’ve essentially used the 529 account as a tax-deferred savings account similar to a traditional IRA. It would still have been better to have used the funds completely tax-free for education, but that doesn’t always pan out for every situation.

Photo by Tim Gouw on Unsplash

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Financial Analyst, CFP®

Elizabeth Brew is a financial analyst with Marotta Wealth Management. She grew up in Belgium, Greece, and Kuwait and enjoys reading, solving puzzles, and finding new things to do in Charlottesville.