Raid 529 to pay debt if college is covered

Dear Dr. Don,
We opened up a 529 college savings plan for our one and only son the day he was born. Since that time, my husband has transferred his Post-9/11 GI Bill benefits to my son, which will pay his college expenses for four years.

Our question: Would it hurt us to withdraw some of the money out of his 529 plan to pay off our debt since our son’s college costs are pretty much covered?
— C.C. Collegiate

Dear C.C.,
As I learned from you, and then learned more about it on the GI Bill’s Web page that covers the transfer of Post-9/11 GI Bill benefits to dependents, starting Aug. 1, 2009, service members enrolled in the Post-9/11 GI Bill program could transfer unused educational benefits to their spouses or children.

Your contributions to a 529 college savings plan were made with after-tax dollars, although you may have received a tax credit on your state income tax return(s) for those contributions. If you received a tax credit for contributions, then a nonqualified distribution could trigger state income taxes on the distribution.

Nonqualified distributions of investment earnings are taxable as ordinary income, so you may owe a 10 percent penalty on the earnings as well. The investment earnings are taxable income to the recipient, who is usually the account owner. There is an exception to the penalty tax, dealing with veterans’ educational assistance. You will have to talk to your tax professional on that one since you’re looking at taking the money out now while the educational assistance isn’t taking place until your son enrolls in school.

If you have your son’s college education handled, then raiding the 529 plan to pay down debts can make sense. There are tax implications, but they deal with the investment earnings and any state tax deductions. Get professional tax advice, and you’ll know the price you’ll pay to take money out of this account.

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