The Perils of Raiding a College Savings Account

While college savings plan balances continue to reach year-over-year highs, some parents are unwisely dipping into their accounts to cover debts or pay for other discretionary expenses such as vacations and weddings.

According to a 2016 study by money management firm T. Rowe Price, nearly half (45 percent) of respondents with 529 and other types of college savings accounts said they took money from their accounts in the past two years.

Most withdrawals were used for home repairs, buying a car, paying health care costs, and other expenditures unrelated to education. Just 18 percent of parents used some of the money they took from savings to pay for their children’s education. Only 3 percent of parents used all of their withdrawals to pay for education.

The survey had some good news: Parents who have 529 plan accounts were less likely to spend their savings on things other than college. It found that 38 percent used withdrawals from 529 plans for nonqualified purposes. While that was a large percentage, it was “significantly less” than the 49 percent of parents who took money from non-529 plan accounts and used those funds for something other than education.

Other than for true emergencies, it’s rarely wise to raid a college savings account. Fewer dollars saved today means more dollars that must be borrowed and repaid with interest in the future.

Owners of 529 plan accounts who make nonqualified withdrawals face particular challenges. The earnings portion of a nonqualified withdrawal will incur federal income tax and a 10 percent penalty on the earnings. Utah account owners who have UESP accounts must also pay state income tax on the earnings portion of a nonqualified withdrawal, as well as repay any state tax credit or deduction previously taken.