New GI Bill pays children's college

By: Savingforcollege.com

Q:

Dear Joe, We put some money away in a 529 plan for our daughter, but now we are planning to use the Post-9/11 GI Bill that will pay for almost all of her college expenses. Will this qualify for the scholarship exception, so that we can take penalty-free withdrawals from the 529 plan when she gets to college? --Barbara

A:

Dear Barbara,

It appears the answer is yes. Any education benefits you receive under the Post-9/11 GI Bill will make you eligible for the scholarship exception. This means you will be able to take withdrawals from your 529 plan up to the amount of GI Bill education benefits received without incurring the usual 10 percent penalty tax on nonqualified withdrawals.

The 529 penalty exception applies to scholarships that are tax-free under Section 117 of the Internal Revenue Code, to benefits for U.S. military service under Chapters 30, 31, 32, 34 or 35 of Title 38, or Chapter 1606 of Title 10 of the U.S. Code, and to payments other than gifts or bequests for higher education which are excludable from gross income under any law of the United States.

Although the Post-9/11 GI Bill is found in Chapter 33 of the U.S. Code, which is not specifically mentioned, the payments made under the Post-9/11 GI Bill are excludable from gross income and therefore should be eligible under the third category of benefits.

Remember, just because the penalty is waived does not mean you avoid income tax on your 529 plan withdrawals. The funds withdrawn and not used for the beneficiary's qualified higher education expenses are treated as nonqualified withdrawals. The earnings portion of these withdrawals must be reported on either your or your daughter's federal income tax return, depending on who receives the withdrawal checks. If you live in a state with a personal income tax, check the rules of that state to determine if penalty-free scholarship withdrawals might also qualify as tax-free on the state level.

If you expect the total of your Post-9/11 GI Bill payments to be more than the balance in your 529 plan, you can consider making additional contributions to your 529 plan. Although the earnings will not be tax-free, they will be tax-deferred, and you may be able to shift the income to your daughter’s lower income-tax bracket during the withdrawal years. Depending on where you live, and which 529 plan you use, you might also be eligible to claim a state income tax deduction for your contributions. However, be sure to speak with your tax professional first.