Simple 529 Plan Question

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Simple 529 Plan Question

Postby RyeWhiskey » Thu Dec 20, 2012 10:16 pm

Greetings fellow Bogleheads,
I have a simple question re: 529 plans. I am considering opening one for myself - I'm 26 and plan to attend a MFA program in the future (4+ years?), possibly even attend grad school. I understand that one can withdraw assets from a 529 plan for "qualified educational expenses." If one's withdrawal is not for said expenses, one is taxed on the withdrawal and "an additional 10% tax penalty is applied to the earnings."

My question is then:
Could one not simply use the earnings for "qualified educational expenses" and count the principle (which does not receive the additional tax penalty) as more tax-deferred investment space? I.e. one could use the principle for retirement without being hit with the penalty, in the mean time it grows tax-deferred.

As always, thanks and cheers! :sharebeer
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Re: Simple 529 Plan Question

Postby letsgobobby » Thu Dec 20, 2012 10:25 pm

No, withdrawals are prorated. But you can be a half time student in retirement and use the money tax and penalty free then.
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Re: Simple 529 Plan Question

Postby RyeWhiskey » Fri Dec 21, 2012 1:29 am

letsgobobby wrote:No, withdrawals are prorated.


Pardon my ignorance, but what do you mean by this?

letsgobobby wrote:But you can be a half time student in retirement and use the money tax and penalty free then.


True. But I would still be forced to use the money on 'qualified educational expenses' whereas I had been hoping to use it (the principle at least) as retirement funds.
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Re: Simple 529 Plan Question

Postby letsgobobby » Fri Dec 21, 2012 1:46 am

Room and board are qualified and I for one might like to be a half time student on Maui for one semester per year.

If you have a $1000 529 and have made $800 in contributions, then you have $200 in gains. For any dollar you withdraw, 2/10 will be considered a gain and 8/10 will be your contributions. You can't segregate out the contributions or gains and withdraw only one or the other. That is what prorated means.
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Re: Simple 529 Plan Question

Postby happymob » Fri Dec 21, 2012 8:09 am

RyeWhiskey wrote:
letsgobobby wrote:No, withdrawals are prorated.


Pardon my ignorance, but what do you mean by this?

When you withdraw money, you don't get to choose whether you are withdrawing principle or gains. If you originally put in $5,000 and it is now $10,000, any withdrawal (qualified or not) will be 50% principle and 50% gains. This is very different from Roth IRA withdrawals, for example, where you can pull out principle tax and penalty free and leave gains untouched. .
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Re: Simple 529 Plan Question

Postby FinancialDave » Fri Dec 21, 2012 7:41 pm

RyeWhiskey wrote:Greetings fellow Bogleheads,
I have a simple question re: 529 plans. I am considering opening one for myself - I'm 26 and plan to attend a MFA program in the future (4+ years?), possibly even attend grad school. I understand that one can withdraw assets from a 529 plan for "qualified educational expenses." If one's withdrawal is not for said expenses, one is taxed on the withdrawal and "an additional 10% tax penalty is applied to the earnings."

My question is then:
Could one not simply use the earnings for "qualified educational expenses" and count the principle (which does not receive the additional tax penalty) as more tax-deferred investment space? I.e. one could use the principle for retirement without being hit with the penalty, in the mean time it grows tax-deferred.

As always, thanks and cheers! :sharebeer


I am not sure why you would want to seriously overfund your 529 plan, as I personally think there are better lower cost options - even in a taxable account using tax efficient index funds. Alternately why not consider putting more money into and HSA account, to fund your retirement healthcare needs.

Despite all that say you get into your last couple years of grad school and you see you have extra money left over, there are 5 or 6 reasons why the 10% penalty would not apply, such as you received other tax-free money from your employer, or the school (scholarship). In those cases you can at least avoid the penalty and over withdraw at least as much as your other tax-free education money.

See IRS pub 970 for details

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