Questions about 529 plan and the scholarship exception? What happens to the money?

So my son just found out he's getting a full ride scholarship to college next year (so proud!!) but now I'm worried about what happens to all the money we've been saving in his 529 plan for the past 15 years. We've put away about $87,000 and were planning to use it for his education expenses. I've heard there's some kind of "scholarship exception" with 529 plans where you can withdraw money equal to the scholarship amount without the usual 10% penalty, but you still have to pay income tax on the earnings portion? Is this correct? Also, what exactly counts as "qualified expenses" that we could still use the 529 money for tax-free? Does his off-campus apartment rent count? What about a laptop or meals that aren't covered by his meal plan? Any advice would be greatly appreciated since we definitely don't want to pay penalties if we don't have to! Thanks in advance!

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20 comments

Jordan Walker

•8M

You're in a great position - congratulations on your son's scholarship! Yes, there is indeed a scholarship exception for 529 plans. You can withdraw an amount equal to the scholarship without paying the 10% penalty, but you will still need to pay income tax on the earnings portion of that withdrawal (not the principal you contributed). For qualified expenses that you can still use the 529 for tax-free: Certain off-campus housing can qualify, but it cannot exceed the school's published room and board allowance for financial aid purposes. Technology items like laptops definitely count if they're used primarily for education. Meal plans or food costs can qualify if they're part of the institution's official cost of attendance.

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Jordan Walker

•8M

Textbooks absolutely qualify as tax-free 529 plan expenses! They're considered required educational expenses, so you can definitely use 529 funds for those without any tax implications. There's no time limit on using 529 funds - they can remain in the account indefinitely. If you have leftover funds after your daughter graduates, you have several options: keep it for graduate school, transfer it to another qualifying family member (sibling, cousin, even yourself for continuing education), or withdraw it (with taxes on earnings and possibly the 10% penalty unless an exception applies).

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Elijah O'Reilly

•8M

I went through something similar with my daughter's college fund last year. I found this amazing tool called taxr.ai (https://taxr.ai) that really helped me understand all my options with the 529 plan and scholarship situation. It analyzed my specific situation and showed me exactly what qualified expenses I could use the money for without penalties. The software even showed me how to document everything properly in case of an audit. Seriously made the whole process way less stressful!

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Elijah O'Reilly

•8M

Yes, it absolutely helps with the tax forms! It guided me through exactly which forms I needed for our situation and even pre-filled a lot of the information based on my inputs. Super helpful for complex family situations like yours. For state-specific rules, that's actually where it really shined for me. I'm in Pennsylvania, and the tool automatically applied the state-specific regulations. It has a comprehensive database of all state 529 plan rules, including Indiana's specific requirements. It actually flagged a state-specific deduction I would have completely missed otherwise.

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Olivia Van-Cleve

•8M

Just wanted to follow up about that taxr.ai site someone mentioned. I was skeptical but decided to try it since our scholarship/529 situation was getting complicated. It was actually incredibly helpful! The system analyzed our specific state rules (Indiana has some unique ones) and showed me exactly how to handle the qualified expense documentation. It even caught a mistake my accountant had made regarding our state tax credit for 529 contributions. Definitely worth checking out if you're dealing with scholarship/529 questions!

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Mason Kaczka

•8M

If you need to talk directly with the IRS about your 529/scholarship situation, I highly recommend using Claimyr (https://claimyr.com). I spent DAYS trying to get through to the IRS about my son's scholarship and 529 withdrawal questions last tax season. It was beyond frustrating. Then I found Claimyr and they got me connected to an actual IRS agent in about 15 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c. The agent walked me through the exact documentation I needed for the scholarship exception and confirmed which expenses qualified. Saved me so much time and stress!

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Mason Kaczka

•8M

It's definitely not a scam! The service uses technology to navigate the IRS phone system and wait on hold for you. When they reach an agent, they call you and connect you directly to that agent. It's completely legitimate - you're actually speaking with real IRS employees. I was extremely skeptical too, especially after months of frustration. But the service works exactly as advertised. They use an automated system that navigates the IRS phone tree and waits in the queue. They only charge if they successfully connect you to an agent. It saved me literally days of time and frustration when I needed specific answers about the 529 scholarship exception.

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Evelyn Xu

•8M

I need to eat my words about that Claimyr service. After posting my skeptical comment, I was desperate enough to try it. I honestly couldn't believe it worked. After three months of trying to reach someone at the IRS about my 529 withdrawal issues, Claimyr got me through to an agent in about 20 minutes. The agent clarified exactly how to report my daughter's scholarship on our taxes and which 529 withdrawals would qualify for the exception. Definitely worth it, especially when dealing with something as complicated as 529 plans and scholarships where the rules aren't always clear online.

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Dominic Green

•8M

Yes, you absolutely can make yourself the beneficiary! The IRS allows you to change the beneficiary to any qualifying family member, which includes parents. You don't need to do anything special beyond the normal beneficiary change form from your 529 plan administrator. It's a simple process - usually just a form where you designate yourself as the new beneficiary. Many people don't realize this is an option, but it's completely legitimate. I have a friend who used leftover 529 money to go back and get her MBA after her kids finished college.

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Cedric Chung

•5M

This is such great news about your son's scholarship! I went through something similar when my daughter got a merit scholarship that covered most of her tuition. Here's what I learned: The scholarship exception is real and works exactly as described - you can withdraw up to the scholarship amount without the 10% penalty, but you'll still owe income tax on the earnings portion. Make sure to keep that official scholarship award letter! One thing I wish I'd known earlier: you can actually use 529 funds for more than you might think. Beyond the obvious tuition and fees, we were able to use it for her required course materials, a laptop for school, and even some of her off-campus housing costs (though there are limits based on the school's published room and board allowance). Also, don't feel pressured to use it all right away. We kept some in the account for potential graduate school expenses, and you can always change the beneficiary later if needed. With $87,000 saved, you have lots of flexibility to make this work to your advantage. The scholarship exception gives you a great safety net for accessing the funds without penalties if you need them for other purposes. Definitely document everything carefully - keep receipts for qualified expenses and that scholarship letter. Congratulations again on raising such a successful student!

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