529 plans and scholarships

Winning a scholarship changes what you can do with college savings, and the rule that governs it is more forgiving than most families realise.

Normally, withdrawing 529 money for anything other than qualified education expenses triggers income tax on the earnings plus a 10% penalty. The scholarship exception removes the penalty: if a beneficiary receives a scholarship, you may withdraw up to that amount without the 10%, though earnings are still taxable.

That matters because the alternative instincts are usually worse. Families often either leave the money untouched indefinitely or take a penalised withdrawal without knowing the exception exists.

There are other routes that avoid tax entirely. You can change the beneficiary to another qualifying family member—a sibling, and in many cases a wider set of relatives—and the account continues untouched.

You can also simply leave it. 529s have no expiration, and graduate school, professional programs, and in many cases a limited amount of student loan repayment are qualified expenses. A scholarship in undergrad doesn't strand the money.

Coordinate with the aid formula. Parent-owned 529 assets are assessed relatively lightly, while distributions and student-owned assets can be treated less favourably, so who owns the account and when you withdraw affects next year's aid.

This is one of the few places in the process where a short conversation with a tax professional is worth it, because the numbers are usually large enough to justify getting the sequencing right.