Earning a Scholarship? 529 Is Still the Smart Way to Save for College

As a parent, you envision the day your child receives that all-important acceptance from his favorite college. Perhaps, he’ll also receive a scholarship for his hard work. It’s an important goal, and it could certainly happen. If it does, what happens to the money you’ve worked hard to save in your 529 plan?

As South Carolina’s Treasurer, I frequently remind families about the importance of saving for a loved one’s future education. After all, young people are now graduating with an average student loan debt of $30,000 that can take years to repay.

I also share with parents the opportunities that investing in a 529 college savings plan can provide, yet many parents voice concerns that they could lose their savings if their children are awarded scholarships. Nothing could be further from the truth. In fact, you have a number of options.the importance of saving for a loved one’s future education. After all, young people are now graduating with an average student loan debt of $30,000 that can take years to repay.

You can use funds for items not covered by the scholarship but related to education, such as fees, books, supplies, and computers, or your savings can be applied to your child’s pursuit of a higher degree after he earns his undergraduate degree, such as medical school, law school or graduate school.

You can transfer the account to a new beneficiary who is a relative of the original beneficiary, including yourself as account owner. You can even retain your savings for your grandchild’s college education.

Because your child received a scholarship, you can withdraw funds from the 529 plan up to the same amount as the scholarship without incurring the 10 percent federal penalty normally applied to withdrawals not used for qualified educational expenses. Joe Hurley, founder of savingforcollege.com, says that earning a scholarship simply “turned your tax-free 529 investment into a tax-deferred 529 investment.” Only the earnings portion of your savings will be subject to taxes. Your contributions will not be taxed.

And you can always withdraw all of your funds. Your 529 savings account is similar to a 401(k) or IRA retirement account. A penalty is applied if funds are drawn from the account and used for a reason other than the intended purpose. A 10 percent federal tax will be charged on the earnings portion of your withdrawal beyond the amount of the scholarship, and you will owe state and federal taxes on the withdrawal. Your contributions will not be taxed or penalized since they were made with after-tax funds.

Of course, not everyone will be able to count on a scholarship to cover all of their educational expenses. That’s why I encourage families that it is never too early – or too late – to start saving for a child’s future with a 529 savings account. The dollars parents save and invest now may be dollars neither they nor their child will have to borrow when it comes time for college or trade school.

And parents aren’t the only ones who can contribute to a child’s 529 account. Family members and friends can also contribute to these education savings accounts and take advantage of tax credits or deductions based on which state you reside. For example, in South Carolina people can deduct 100 percent of their contributions to a 529 account on their state income tax return.

If it turns out a scholarship is not in your child’s future, a college education still can be, and every dollar you save in a 529 plan today reduces the amount you may need to borrow to reach that very important goal.

About the Author:
Curtis Loftis is South Carolina’s State Treasurer. He administers the Future Scholar 529 College Savings Plan. Visit treasurer.sc.gov or futurescholar.com for more information on ways to save through a 529 plan.