How a Scholarship Affects Your 529
These three tips can help you maximize the tax benefits of 529 accounts.
Q: If you save money in a 529 and then your child gets a scholarship, what is the best course of action?
A: If you're in the enviable position of having diligently saved for your child's college education and he or she earns a scholarship, you can withdraw the money in the amount of the scholarship and the 10% nonqualified withdrawal penalty is waived on that amount. This might not be the best course of action because you will pay ordinary income tax on the earnings portion of your 529 balance. (The contributions were made with aftertax dollars, remember, so the amount over the contribution amount represents earned income that has not yet been taxed.)