How Scholarships Impact Your UESP Account
Great news: Your graduating high school senior has received a merit-based scholarship that will pay for much—maybe even all—of his or her higher education.
But what does it mean for your college savings?
For years, you made regular contributions to your UESP college savings account, and the account now has a balance that your child no longer needs. That presents a dilemma. The earnings portion of a withdrawal that you don’t use for qualified higher education expenses is subject to state and federal taxes and a 10 percent federal tax penalty. Also, if you are a Utah taxpayer and previously took a tax deduction or credit, the apportioned withdrawal is subject to recapture.
What should you do?
Fortunately, there are options that can help you avoid or minimize the unpleasant tax consequences of making a nonqualified withdrawal of funds from your account.
Use your account to plug the gaps. Most academic scholarships do not pay for every qualified expense your child will incur. Use your UESP account funds to cover any tuition and fee deficits.
You can also withdraw funds to buy books, computers, software, and related equipment. Room and board expenses are qualified expenses, as long as they don’t exceed the amount determined by the eligible educational institution for a student enrolled at least half time. Withdrawals need to be made within the same time period of the expense.
Delay withdrawals. Save any unused account funds in case your child decides to pursue a graduate degree, or enter law school or medical school. Your UESP account can be used to pay those expenses.
Change your account beneficiary. Instead of closing your account by making a nonqualified withdrawal of your funds, you can change the account beneficiary without harmful tax consequences, as long as the new beneficiary is a member of the family of the previous beneficiary. Family members include, among others, a brother, sister, parent, and first cousin. See the Program Description for a complete list of qualified family members.
To make a change, submit a Beneficiary Change/Correction form (form 510), which can be downloaded at my529.org. If you wish, you may also change your account investment option while changing the beneficiary, without it counting as one of two allowable investment option changes per year. You can even keep the money in your account and change the beneficiary at a future date.
If you must make a nonqualified withdrawal, limit the size. Internal Revenue Service rules allow account owners to make a nonqualified withdrawal of funds up to the amount of the scholarship without being required to pay a 10 percent federal tax penalty on the portion of the withdrawal that is earnings. The earnings portion will still be subject to federal and state income taxes.
Please consult a tax advisor first before proceeding if you have questions about your particular situation.