By Scott Wolkens
A popular option to save for college is a 529 tuition savings plan. However, most parents (and grandparents!) are not aware that you may use a 529 for federal tax-free withdraws to pay for private K-12 education. You can take a federal tax-free distribution from a 529 plan of up to $10,000 per calendar year per beneficiary to help pay for tuition at a K-12 private school.
When you fund a 529, the money you contribute doesn't go in tax-free. But you can earn interest on the money in the account. As that money is invested and generates returns, you're not liable for gains on your account's earnings year after year. Rather, you get to reinvest those earnings to accumulate an even higher savings balance. Then, when the time comes to withdraw from your 529, that money is not taxable—provided, of course, it was used for a qualified education expense at a qualified school.
Your child tells you that they want to study abroad in Paris
The good news is that distributions from 529 college savings plans can also be used tax-free to study abroad, but is subject to certain restrictions. In particular, the distribution must be used to pay for qualified higher education expenses at an eligible educational institution. Eligible educational institutions include colleges and universities that are eligible for Title IV federal student aid. There are two different ways to study abroad:
If post-secondary education isn't in the cards
Even if your child's path doesn't include any type of post-secondary education, you still have options. You opened the 529 for the benefit of your child, but the account belongs to you and you have the right to change the beneficiary. Most 529 plans allow you to change the beneficiary once a year, so that leaves the door wide open for future use. You could even convert it back to your original child's benefit should his plans change.
As long as the new beneficiary is a family member—a sibling, first cousin, grandparent, aunt, uncle or even yourself—the money can be used for qualified education expenses without incurring income taxes or penalties. Qualified expenses include tuition, required fees, books, supplies, computer-related expenses, even room and board for someone who is at least a half-time student.
This flexibility gives you a lot of options. Let's say you decide to go back to school. You make yourself the beneficiary and use 50% of the 529 assets for your studies. What do you do with the balance? You could simply change the beneficiary to another member of your family who could use it for their own qualified education expenses
Taking the cash is always a possibility, but it will cost you. If assets in a 529 are used for something other than qualified education expenses, you'll have to pay both federal income taxes and a 10% penalty on the earnings. (An interesting side note is that if the beneficiary gets a full scholarship to college, the penalty for taking the cash is waived.)
Since one of the main benefits of a 529 account is the federally tax-free earnings, think carefully before cashing it out. And really, it might be wise to sit tight before making any decisions. Your child may surprise you again by going in a whole new direction and you'll be glad you've kept those 529 assets in reserve.