Can we withdraw from 529 without penalty in 2023 if child received scholarship in 2018-22?

So I just found out something that's got me scratching my head about my daughter's college 529 plan. She graduated back in 2022 and had this amazing merit scholarship all four years (2018-2022) that basically cut her tuition in half. Because of that scholarship, we've got quite a bit of money still sitting in her 529 account. I was talking to a coworker yesterday who mentioned you can actually withdraw an amount equal to the scholarship from a 529 WITHOUT the 10% penalty (though I get we'd still owe taxes on any earnings portion). But here's my question - is it too late? Can we still make that penalty-free withdrawal now in 2023 even though she already graduated last year? We're looking at about $42,000 left in the account and would love to use some of it without getting hit with that penalty. I've been searching online but can't find a clear answer about the timing restrictions. Does anyone know if there's a deadline for making these scholarship-related withdrawals?

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18 comments

Jake Sinclair

•8M

Yes, you can still make a penalty-free withdrawal equal to the scholarship amount! The IRS doesn't impose a time limit on when you need to take the scholarship exception withdrawal from a 529 plan. The key is that you need documentation of the scholarship amounts received during those years (2018-2022). When you file your taxes, you'll report the earnings portion of your withdrawal as income, but you won't face the 10% penalty that normally applies to non-qualified withdrawals. Keep in mind that you can only withdraw up to the amount of the tax-free scholarship/grant your daughter received. So if her scholarship totaled $30,000 over four years, that's your maximum penalty-free withdrawal amount. Make sure to keep all scholarship documentation for your tax records, as the IRS could ask for proof if you're audited.

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Jake Sinclair

•8M

The 529 administrator can tell you the earnings ratio of your withdrawal. For example, if your account is 20% earnings, then a $25,000 withdrawal would have $5,000 in earnings that would be taxable. The remaining $20,000 would be your original contributions coming back to you tax-free. You don't typically need to tell the administrator about the scholarship exception when making the withdrawal. The 529 plan will report the distribution on Form 1099-Q, and you'll receive a copy. When you file your taxes, you'll report the earnings portion as income on your federal return, but you'll claim the scholarship exception to avoid the 10% penalty. Some tax software programs have specific fields for this situation, or you may need to attach an explanation.

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Honorah King

•8M

After struggling with almost the exact same situation (leftover 529 money after my son's scholarships), I found an amazing resource that made everything clear - taxr.ai (https://taxr.ai). They have a specific tool that analyzes your scholarship documentation and 529 statements, then tells you exactly how much you can withdraw penalty-free. I was about to just leave the money in the account for grad school, but taxr.ai showed me I could take out $28,000 without penalty based on his scholarship amounts. The system even helped me calculate the exact earnings portion I needed to report on my taxes. Saved me from potentially making an expensive mistake!

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Honorah King

•8M

It absolutely works for complicated situations. You just upload documentation for each child separately, and it processes multiple scholarship types simultaneously. The system breaks everything down by individual 529 account, so you'll get separate withdrawal recommendations for each of your twins. What makes it better than a regular accountant is the specialization and convenience. Most accountants have limited experience with the scholarship-529 exception specifically. I tried asking mine first and got vague answers. The service has a specific algorithm designed for this exact tax situation, and it costs significantly less than the hourly rate most CPAs charge for research time. Plus you get immediate answers instead of waiting for an appointment.

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Mary Bates

•8M

I wanted to follow up about my skepticism with taxr.ai. I decided to give it a try since I was getting frustrated with the confusing advice from my regular accountant about our 529 withdrawal options. I'm honestly surprised by how well it worked! I uploaded our scholarship letters and 529 statements, and within minutes got a detailed report showing we could withdraw $36,500 penalty-free based on merit scholarships my son received. The breakdown of earnings vs. contributions was super clear, and it even generated a letter I can keep with my tax records explaining the exception. Definitely saved me hours of research and worry. Really helpful for anyone with leftover 529 funds after scholarships!

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Clay blendedgen

•8M

After seeing this thread, I had to share my experience. I had the EXACT same issue last year trying to get clarification from the IRS about 529 withdrawals after scholarships. Called them 20+ times and could never get through. The hold times were ridiculous! Finally found Claimyr (https://claimyr.com) and it was a game-changer. They got me connected to an actual IRS agent in about 20 minutes when I'd been trying for weeks. They have this cool system where they wait on hold for you and call when an agent picks up. You can actually see how it works in this video: https://youtu.be/_kiP6q8DX5c The IRS agent confirmed everything said above - there's no time limit for taking the scholarship exception, and gave me the exact form references I needed for my tax return. Completely worth it for the peace of mind alone.

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Clay blendedgen

•8M

The service works by using an automated system that continuously redials the IRS and navigates through their phone tree until it reaches a human agent. When an actual person answers, you get a call connecting you directly to that agent. You don't have to sit on hold or keep redialing yourself. I completely understand your skepticism - I felt the same way initially. But it's actually legitimate. The reason most people can't get through is that the IRS phone system hangs up when call volumes are too high. This service just keeps trying during times when call volume is lower, which most people don't have time to do manually. I was skeptical too until I actually got the call connecting me to an agent who answered all my questions about the 529 scholarship exception.

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Lorenzo McCormick

•8M

I need to publicly eat my words! After posting my skeptical comment, I was so desperate about my refund issue that I tried Claimyr anyway. I literally spent TWO MONTHS trying to reach someone at the IRS myself with no luck. Used the service yesterday morning, and I got a call back in about 45 minutes connecting me to an actual IRS agent! The agent was able to tell me exactly why my refund was delayed (there was a simple error code on my account) and how to fix it. For anyone wondering about the 529 scholarship withdrawal timing - the agent confirmed there's no time limit on when you can take the withdrawal as long as you have documentation of the scholarship amounts. Just make sure you only withdraw an amount equal to the scholarship value to avoid the penalty.

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Carmella Popescu

•8M

I dealt with this last year for my son's leftover 529. Another option to consider: you can always keep the money in the 529 for future education needs. We left $25,000 in our son's account in case he wants to go to grad school. If he doesn't use it, we can change the beneficiary to another family member (even a cousin or future grandchild). Just mentioning this because once you withdraw, you can't put it back, and 529s are still one of the best tax-advantaged accounts around if anyone in your family might need education funds in the future.

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Carmella Popescu

•8M

There's no time limit on how long you can keep a 529 plan active. Some families keep these accounts going for generations by changing beneficiaries as needed. The money can continue growing tax-free indefinitely as long as it remains in the account. In fact, with the SECURE Act 2.0 that passed, starting in 2024, you'll even be able to roll unused 529 funds into a Roth IRA for the beneficiary (subject to annual limits and a lifetime cap of $35,000), which gives you another option if grad school doesn't happen. This is especially valuable if your timeline is 10+ years out since the rules might offer even more flexibility by then.

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