When you’re paying off credit card debt, your first instinct will likely be to tap all available resources to get rid of it as soon as possible. In the case of your bloated savings account, this is probably a good thing. But tapping other funds — like those in a tax-advantaged retirement or 529 account — may cost you in taxes and fees. Here’s what you need to know about the benefits and drawbacks to using your child’s 529 to pay off debt.
What’s a 529 plan?
A 529 plan is a tax-advantaged investment vehicle created to save for a beneficiary’s higher education expenses. Your earnings will not be taxed by the federal government and generally will not be taxed by your state government either. 529 plans offer state tax advantages and they can cover tuition, fees, books and supplies for school.
Do I have the ability to withdraw money earmarked for my child?
If you purchased the 529 plan, you’re the custodian and you can choose to withdraw the money from it. If someone else purchased the 529 plan, like your child’s grandparent or another relative, you don’t have access to it. If the grandparent contributes the money to the 529 plan of which you’re the custodian, you’ll have access to that money — although, I don’t suggest using Grandma’s contributions to pay off debt without her permission.
The benefits of withdrawing money from my child’s 529 plan to pay off debt
- You’ll get out of debt faster! Of course, the major benefit is being able to pay off your debt faster than you could have otherwise. While you may worry about taking your kid’s college fund away from him, getting out of debt should be your priority. Student loans exist at reasonable interest rates, but credit card rates are in the double digits and can take years or even decades to pay off making minimum payments.
- You — and, in turn, your child — will be less stressed out. Having a large amount of debt can put financial and emotional stress on your family. By eradicating it faster, you’ll be more relaxed, and your child will likely follow suit.
» MORE: How to pay off debt
The drawbacks of withdrawing money from my child’s 529 plan to pay off debt
- You’ll have to pay taxes on nonqualified earnings withdrawals.
- You’ll also have to pay an early distribution penalty. As with early 401(k) withdrawals, you’ll incur a 10% early distribution penalty on 529 earnings distributions when not used to cover higher education expenses for the beneficiary.
- Your contributions are limited each year. 529 plans have an annual contribution limit of $14,000. If you withdraw the funds, you won’t be able to get those years back.
- The money won’t be there when the beneficiary is ready for college. A major concern is that the money won’t be accessible for your child or other beneficiary anymore. While this may not be ideal, you may be able to build up this savings again once the high-interest-debt monkey is off your back.
Bottom line: Provided you’re the custodian of a 529 plan, you have the ability to withdraw the money at any time to pay off your debt. There are benefits and drawbacks to doing this, but whether or not it will be worth it will depend on your state tax and credit card interest rates, as well as the amount of money the account has accrued.
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