Savvy Ways to Take Withdrawals from College Accounts

How not to run afoul of the rules when using tax-advantaged accounts

When it’s time for making withdrawals to pay for college, a 529 plan or Coverdell account works

Chana R. Schoenberger of the Wall Street Journal

Jan. 7, 2018 10:14 p.m. ET

We again asked experts to help address readers’ questions on saving for college. The main focus here is on sticking points when it is time to take money from “529” college-savings plans and other college accounts.

What is the best strategy to handle withdrawals from tax-advantaged accounts to pay for college?

“If you’re setting up a savings account strictly with the intention of paying for a child or grandchild’s future college expenses, we would rank the following tax plans as follows: 529 plans and Coverdell accounts, Roth IRA, traditional IRA and then a 401(k) plan, which offers no income-tax benefits for qualified education expenses,” says Charlie Javice, chief executive of college-finance information site Frank (

She says that is because both 529 and Coverdell accounts allow you to withdraw money for qualified education expenses without paying taxes or penalties. With a Roth IRA, early withdrawals, before age 59½, are normally subject to income tax and a 10% penalty on the earnings portion, but there is a special exception when the funds are withdrawn to pay for qualified higher-education expenses for you, your spouse, your children or your grandchildren. In this case, the 10% penalty will be waived, but you will pay income tax on the earnings portion (if any) of the distribution. Traditional IRA holders will owe income taxes on any money they withdraw above their deductible contributions, Ms. Javice says.

“It should also be noted that while an IRA is not factored into the federal Fafsa student-aid form, any withdrawal made from the account—even for noneducation expenses—does need to be listed as income on the application, increasing the student’s Expected Family Contribution,” Ms. Javice says.

Because the Fafsa penalizes student-held assets more than those held by parents, it is more beneficial for a Roth IRA to be held by the parent if you intend to use it to pay for college, she says. When Fafsa calculates each applicant’s ability to pay, 20% of assets owned by the student are considered payable toward their education expenses, while for parents, only 5.64% of nonretirement assets are counted. When students receive money from a 529 owned by a grandparent, meanwhile, that money is only required to appear on the student’s aid application two years after the money was initially spent.

Note that you can use tax-advantaged status for specific expenses once, not multiple times. For example, the American Opportunity Tax Credit (AOTC) lets families claim a tax credit for 100% of the first $2,000 and 25% of the next $2,000 of a dependent child’s tuition and related expenses each year, for a maximum total credit of $2,500, says Kathryn Flynn, content director at, a college-finance information site.

Since there is no double-dipping, you would have to subtract the $4,000 used to generate the AOTC from your total qualified expenses before you take a withdrawal from a 529 plan or Coverdell ESA. That means if you spent $15,000 on qualified education expenses this year, and claimed the AOTC, you will only be able to withdraw $11,000 tax-free from a 529 or Coverdell ESA.

Do withdrawals from a 529 or a Coverdell have to be spent during the same year in which they are made?

Yes. “The IRS limits the amount that can be withdrawn from those savings plans to the student’s qualified higher-education expenses for a given tax year, even though one tax year includes two academic years,” Ms. Javice says.

Are Coverdell accounts treated the same way as 529s for tax purposes? How about for financial-aid purposes?

There’s a difference for tax purposes. Both accounts can be used to pay for K-12 tuition, as well as for college tuition, because under the newly passed tax plan, 529s now also offer K-12 tuition withdrawals (Coverdells already did, as well as for other qualified K-12 expenses). Some state tax benefits may only accrue to state residents who invest in their state’s 529 plan, Ms. Javice says.

“Some schools will also use the [College Board’s] CSS Profile to determine need-based institutional aid, and the way 529 and ESA [education savings accounts] assets and withdrawals are counted will vary by school,” says Ms. Flynn.

I would like to set up a plan for college for my 15 grandchildren. Must I have a 529 for each or would a trust from which any could draw be better?

In terms of the Fafsa, the impact is the same, Ms. Javice says. But once you set up a 529, you’ll only be able to use it for one grandchild at a time, changing the beneficiary each time you want to pay for another child to go to college. It will be easiest for you if you set up individual accounts for each grandchild.

Keeping the plans separate, you can invest each one according to the age of the child, and name each child’s parent as the successor owner after yourself, says Ms. Flynn. That way, if something happens to you before the funds are disbursed, each child will have his or her own parent in charge of the funds.

Funds are still left in my daughter’s Coverdell education account. Her new employer will reimburse her if she attends college and gets a master’s degree. As this reimbursement is similar to her receiving a scholarship, can the amount she gets from her employer be used to withdraw the same amount in Coverdell funds in the same fashion (i.e., with no 10% penalty) as if she received a scholarship from the college to attend?

Yes. The rule is that you must pay taxes and a 10% penalty on the earnings portion of nonqualified withdrawals, Ms. Flynn says. But there are a number of exceptions, including cases in which a student gets a tax-free scholarship, dies or becomes disabled, or receives veterans’ educational assistance or employer-provided educational assistance.

Beneficiaries who leave funds in a Coverdell account for graduate school should remember that those funds must be disbursed, or transferred to another family member, before the beneficiary turns 30, Ms. Javice says.