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I read somewhere that overfunding a 529 account could be subject to taxes and a 10% penalty. Does anyone know how this works? Obviously, it is very difficult to predict the tuition costs 10 or 15 years ahead. I understand you can apply the overfunds to a another child or relative, but what if this is not these? Do you pay taxes + 10% penalty on all leftover funds?

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It's really a calculated risk. The most you gain is for the growth to be tax free, the downside (for the excess funds)is the growth is taxed plus the 10% penalty. I'd suggest a simple strategy. Deposit as much as you can, early on, until the balance approaches the current 4 yr college cost. Then, just add enough to match the current cost, i.e. If college costs grow more than the account, just make up that difference.

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In addition to changing the beneficiary of the account, you can withdraw excess funds without penalty if the child dies or is disabled, or if the child gets a scholarship.

Also remember that the tax and penalty is on earnings, not principal.

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    Oh, I didn't know there was an out if your kid got a scholarship. I think that's a common concern among parents. Now when you say "without penalty" ... would you still have to pay taxes on any excess funds withdrawn? Is the principal still tax free if you pay the kids entire education off the principal and still have some left over? – Stainsor Apr 21 '11 at 12:45
  • @Stainsor - if I read the code correctly, withdrawals are first taken from the growth, then from principal, so a partial scholarship would leave a balance one should be able to withdraw at no cost. If I am mistaken, I'm sure a reader will correct. – JoeTaxpayer Nov 29 '12 at 17:08

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