IF YOUR KID GETS A SCHOLARSHIP, YOU SHOULD GET A CUT
Earning a scholarship creates an exception to the 10% penalty rule on 529 withdrawals.
DEAR PETE: My only child just received a full-ride scholarship to the school of his dreams. My wife and I are beyond thrilled, but believe it or not we’re in the midst of a giant disagreement over the aftermath.
We saved very aggressively for his education, at the expense of our own retirement.
My wife believes we should give the money to our son as some sort of reward.
I think we should find a way to transfer that money out of the 529 plan and into our retirement savings, because as of now, we’re not even close to the amount we should have for retirement, primarily because we chose our son’s education over our own retirement. Who’s right? — STEPHEN, OMAHA
DEAR STEPHEN: We don’t have to say someone is right and someone is wrong, do we? I happen to agree with you, but that doesn’t mean your wife is wrong. Stephen, I’ve been married for 16 years — there’s no reason to ever prove your wife wrong. There’s simply no upside to that.
Remember, you sacrificed and contributed to his 529 plan because you wanted his college education funded. Well, it’s funded. Mission accomplished. Similarly, let’s say that on the way home from a meeting, I stop and get my family a pizza for dinner. But upon arriving home, I learn they have already eaten, but I haven’t. Am I supposed to just give them the pizza anyway and sit there and watch them not eat it?
Of course not. GIVE YOURSELF CREDIT I can’t imagine a scenario in which giving your son thousands upon thousands of dollars right now, when he doesn’t need it, makes sense. Especially given the fact that you need it, it’s yours, and he is still getting his education. I understand he earned the scholarship, but it’s not like you didn’t play a role. You nurtured his gifts, you encouraged his studies and activities, and you obviously led by example in holding education in a high regard. You had a gigantic role in his scholarship. The number of parents who believe their child is going to earn a full-ride scholarship is greatly disproportionate from those parents’ children who actually receive one. You did the right thing by saving for your son’s education. However, it generally makes more sense to aggressively fund retirement rather than a college education, primarily because there are means to finance a college education via loans, whereas there are no means to borrow for retirement. You dodged a bullet. You may actually get to have your cake and eat it too. Had he not earned the scholarship, there would be no cake for you.
Fortunately, you won’t be subject to any penalties when you withdraw the 529 money. Earning a scholarship creates an exception to the 10% penalty rule on non-qualified withdrawals. You will still need to pay taxes on the earnings, but you’ve already paid taxes on the contributions, so you’re in the clear there.
Some parents choose to try and fund their children’s education via Roth IRAs, just in case the student ends up not needing the money for college. A Roth IRA can be used to pay for college, but no penalty is incurred when it isn’t used for college. I don’t necessarily recommend solely using the Roth IRA method because of the relatively low contribution limits, the income limits and the lack of state tax benefits compared with many state 529 plans. From what I’ve seen, not needing the money you’ve saved for your kids’ education is exceptionally rare. Preparing for that possibility is prudent but not always worth the hassle.
RETIREMENT IS YOUR REWARD
Here’s the good news, Stephen: Your son’s scholarship is about to jump-start your retirement-strategy. You can turn your cash flow’s focus toward retirement, and you can reassign the focus of the college fund to retirement. Talk with your tax adviser about the best tax-advantaged way to accomplish this.
Congrats. Your family’s focus on education may have just accidentally saved your retirement.