Should You Ever Borrow From Your Kid’s College Fund?

The bills are coming in faster than you can keep up, and your emergency savings fund is just about depleted. You don’t know how you’re going to make ends meet this month. Then you remember that your child has some money stashed away in a 529 Plan for college. If money is tight you might be thinking about taking money from your child’s plan, but is this a good idea? The only way to decide is to look closer at some of the pros and cons. Here are some things you should know before you crack open your child’s piggy bank.

You can’t take out a loan against a 529 Plan

Loan application form with hourglass

Loan application form | iStock.com/TheaDesign

First, know how a 529 Plan works. You cannot take out a loan against the 529 account’s assets. When you take money from your child’s 529 Plan it is not a loan. You can’t borrow money from the account without also taking some of the earnings. Rather, you are making a withdrawal of both principal and earnings. You can, however, put the money back. You’re allowed to redeposit a maximum of $14,000 in one year without being hit with a gift tax.

Know what counts as a qualifying expense

student debt

Student debt | iStock.com

You’ll be hit with penalties and fees if you use 529 Plan distributions for non-qualifying expenses. So if you plan to withdraw money, first see what types of withdrawals are penalized and which are not. So what qualifies? Some qualifying expenses include withdrawals used to pay for books, tuition and fees, room and board, and computers and related equipment. Expenses incurred for special needs services required by a beneficiary with special needs are also qualifying expenses, as long as the services are related to enrollment or attendance. 

Be aware of penalties

IRS

IRS | Win McNamee/Getty Images

You will face tax penalties if you use the money from a 529 to pay for non-qualified expenses. There are some exceptions, such as when the beneficiary receives a scholarship. However, generally, the earnings portion of non-qualified withdrawals will result in federal income tax and a 10% penalty. You’ll have to fill out Form 1099-Q during the years you make withdrawals. This form lets the IRS know which portion of your withdrawal is considered taxable earnings (generally any amount used to pay for non-qualifying expenses). The IRS does offer the option to redeposit any unused withdrawals or school refunds within 60 days so that penalties won’t be incurred. In addition, Uncle Sam might come after you for state taxes if you claimed a tax deduction or credit for your 529 contributions.

Deciding what to do

counting money

Counting cash | Juan Barreto/AFP/Getty Images

If you’re not sure whether to withdraw from a 529 or your retirement accounts, you’ll have to take a look at the big picture. When deciding between the two, know that in the long-run it might be easier on your wallet if you opt to go the 529 route. This is because a 401(k) plan or a traditional IRA is funded with pre-tax contributions. Consequently, you’ll be responsible for federal income tax on both principal and earnings. On the contrary, the deposits put into a 529 Savings Plan are funded with after-tax money. That means you’ll only owe taxes for the earnings portion of a non-qualified 529 withdrawal.

When you think about it, remember that your child has many options when it comes to paying for college. There are grants, scholarships, and loans. However, when it comes to retirement, you don’t really have a lot options. You either have retirement savings or you don’t. No one is going to come and rescue you.   ­­­

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