|Question: My child got a full scholarship to college--now what?|
Since your child has received a full scholarship, you can withdraw--without penalty--some of the funds in your 529 account. In each withdrawal from your 529 plan, you receive some earnings and some of the contributions that were made to the account. Generally, a penalty is imposed on the earnings portion of each withdrawal that you don't use to pay qualified higher education expenses. Your child's scholarship creates an exception. As long as your withdrawals during the year don't exceed the amount of the scholarship for the year, you will not owe a penalty.
Keep in mind that you may owe federal, and in some cases state, income taxes on the earnings portion of each withdrawal. However, you won't owe federal income taxes if your withdrawals during the year don't exceed the amount of your child's scholarship for the year.
Withdrawing the funds isn't your only option. You can leave the funds in the 529 account for your child's future use (some plans allow 529 funds to be used for graduate school). Or, you can change the beneficiary of the 529 account. If the new beneficiary and your child are members of the same family, you won't owe federal income taxes or a penalty when you make the change. But the change of beneficiary could cause a gift tax or a generation-skipping transfer tax, so pick the new beneficiary with care.
Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about 529 plans is available in each issuer's official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.