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I understand that when a beneficiary receives a scholarship the holders of a 529 account can withdraw the scholarship amount from a 529 account without incurring the 10% fee. In particular I am wondering what other types of outside education funding might also waive the 10% fee. In particular I am wondering about

  • the stipend/funded tuition for PhD programs

  • when an employer pays for courses/a graduate degree for an employee who is the 529 beneficiary

  • tuition reimbursements that are a job benefit when the employee is an employee of a university

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The relevant documentation is IRS Pub 970. As usual however, you have to do quite a bit of digging to find clear answers.

In general, there are three cases when withdrawing money from a 529 plan:

  1. Withdraw money to pay for qualified education expenses. (No tax)
  2. Withdraw money without any qualified expenses to match. (Pay income tax +10% penalty on earnings)
  3. Withdraw money equal to the amount of tax-free education assistance, usually this is a scholarship. (Pay only income tax on earnings).

The big sticking point is "double-dipping", which the IRS calls "double-benefit". If a qualified education expense is paid out of tax-free money (regardless of its source), then you cannot also make a tax-free distribution (situation 1 above) from the 529.

The 10% penalty applies in all situations where you make a taxable withdrawal except:

A tax-free scholarship or fellowship grant (see Tax-Free Scholarships and Fellowship Grants in chapter 1);

...

Employer-provided educational assistance (see chapter 11 );

(Emphasis mine, quoted from "Additional Tax on Taxable Distributions" section under QTP)

So the short answer for your situations is "No", the 10% does not apply. Whatever you do, just make sure you're not "double-dipping".

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