Busted 529 Plans - What Gets Taxed?

If you use the funds for qualified higher education expenses, nothing. But that's not the question most people are asking.

What they really want to know is: "If my kid doesn't go to college, what's that going to cost me in taxes?"

Well, if you have another kid (or niece or nephew) waiting in the wings that can use the money for school, nothing. But let's assume Junior is an only child, you don't want the money to go elsewhere, and Junior is not the academic type.


  1. Earnings, not contributions, get taxed at your normal income tax rate - plus - 
  2. You get hit with a 10% penalty on the earnings only, not contributions
  3. If you got a tax break on the contributions, as many states will grant you, you will be subject to a 'recapture' of that amount from the contributions.


Let's assume you have contributed $10,000 to Junior's Missouri MOST 529 plan and taken that amount off your state taxable income over the years. Further, let's say those contributions have grown to $15,000 when Junior decides college is not for him. Finally, we're going to assume the 529 owner/taxpayer is in the 25% Federal and 6% Missouri marginal tax brackets. Let's see what we owe:

  • Earning at normal tax rates: ($15,000 - $10,000) * (25% + 6%) = $5,000 * 31% or $1,550
  • 10% penalty: ($15,000 - $10,000) * 10% = $5,000 * 10% or $500
  • Recapture of tax breaks: $10,000 * 6% (state only, there was no Federal tax deduction) or $600
So your total proceeds are:

-$   500
-$   600

It's important to remember that if you had saved the money outside of the 529 plan, you would have paid taxes on the earnings as you went anyhow and that you would not have received the $600 being recaptured in the first place. Therefore, the only thing you risk by putting the money in a 529 plan and changing your mind is the 10% penalty on the earnings.

If you are a Missouri investor and would like to know more, call (314) 772-9857 or visit www.comptonadvisors.com.