Scenario - In 2005 I put $40 K into an out-of-state 529 plan, no tax ramifications/deductions. Now, the plan is worth $80K. My understanding is that I can withdraw my initial $40K without any tax ramifications since it is just a return of my initial investment and I took noinitial tax benefits. Right, wrong, or ?????
Return of initial Investment in a 529 Plan
Apr 08, 2013
3 Replies
Wrong. You can not pick and choose what part of the balance to withdraw. Every distribution contains contributions and earnings. If you don't spend any part on qualified expenses, then the part of the distribution that is earnings is taxable. In your example you would have taxable earnings being distributed and you would also have to pay the 10% penalty.
Every distribution contains contributions and earnings. If you don't spend any part on qualified expenses, then the part of the distribution that is earnings is taxable. In your example you would have taxable earnings being distributed and you would also have to pay the 10% penalty.
OK - I think I understand. Now, for my example, if I take out $40K, one half ($20K) would be a return of my initial investment and not taxable or penalty fodder, and one-half ($20K) would be capital gains and taxable and subject to penalty???
Every distribution contains contributions and earnings. If you don't spend any part on qualified expenses, then the part of the distribution that is earnings is taxable. In your example you would have taxable earnings being distributed and you would also have to pay the 10% penalty.
Almost. One-half would be ordinary income, not capital gains, and subject to penalty.
Ira Smilovitz
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