7 Times It's Okay to Raid Your 529 Plan

A 529 plan is a great way to save for college. Money can grow tax-free if it's used for qualified education expenses, and many states offer great tax deductions on contributions.

Generally speaking, it's best to avoid tapping into your 529 plan until the beneficiary goes off to school, because otherwise you'll end up paying a 10% penalty and taxes on any gains. Plus, you'll lose out on any future gains that money might have produced.

But that doesn't mean there aren't cases when it's okay to make a nonqualified withdrawal. Consider these seven situations.

1. Most of the Money Is Contributions, Not Gains

If you opened a 529 account recently, or if the fund hasn't performed well, it's possible that the money in the account is made up mostly of the cash you put in. In this case, you might avoid paying tax on any withdrawal, because you're only obligated to pay taxes on the gains. You may even avoid the 10% penalty. It won't hurt you too much to take money out under this scenario if you need it, but you should still consider trying to replenish those funds as soon as you can.

2. It's Performing Poorly and You Think You Can Do Better Elsewhere

In most cases, the tax advantages of using a 529 plan make it worthwhile to use for college savings. But they aren't perfect. Often, account holders are very limited in their investment choices, and may pay high management fees. If you've done an analysis and think you can do better overall using a Roth IRA, ESA Coverdell, or a taxable brokerage account, give it a shot. Just be aware of the tax implications and other possible restrictions if you do.

3. Your Only Other Option Is Raiding Your Retirement

It's often said that you can borrow for college, but you can't borrow for retirement. If you're faced with a financial hardship and are considering dipping into your retirement money, turn to the 529 plan first. We all want to save for retirement and our kids' college educations, but retirement should be the first priority.

4. You're Confident You'll Replenish the Funds in Short Order

Sometimes it's okay to make a withdrawal if you find yourself in a short-term cash crunch. If you were laid off from a job, but have one lined up to start within a month, for example. Under this scenario, if you can take money from the account but put it back relatively quickly, the financial harm is relatively minimal — especially if you didn't take out too much to begin with.

5. You Know Your Kid Isn't Going to College

You may come to the conclusion that the beneficiary of the 529 account is going straight to the workforce, or perhaps joining the military. In this case, it might be worth it to withdraw money now rather than later, when your taxes and penalties may be higher. Before you take the money out, just remember that it's possible to change the beneficiary to another person, such as a younger child, who might be able to use the funds for education in the future.

6. The Beneficiary Lands a Scholarship

Hey, this is a good problem to have. You may be forced to withdraw the money and pay a 10% penalty and taxes on the gains, but otherwise the money is then yours to use as you wish. Congratulate your youngster on his or her hard work.

7. You're at the Maximum Balance

This is another good problem to have, though probably a rare one. If you've been contributing aggressively and the investments have performed well, you may be prevented from adding any more funds to the account. This maximum ranges from $235,000 to $450,000, depending on the state. There's nothing wrong with letting the money sit and grow, but since you're no longer getting a tax advantage on contributions, you may consider taking some funds out and placing it in different investments that will perform even better. Just remember to take penalties and fees into account before making any withdrawals.

Do you contribute to a 529 plan? Have you ever considered borrowing from it?

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