Using 529 Plan to buy a new home

Q: There are some really good deals in real estate these days, and my wife and I would like to buy a new home.
I am the owner of a 529 College Savings Plan for my son and would like to withdraw money this year to use toward a down payment. I know that withdrawals from an IRA used for a first-time home purchase can be penalty-free. Is this also true for college savings plans, and if not, how much tax and penalty will this cost me?
A: Your question raises an interesting point. 529 college savings plans, obviously set up to pay for college, can sometimes provide a source of immediate cash for other needs, such as yours.
The tax advantages of 529 Plans are tax-deferred growth and tax-free withdrawals if the money is used for qualified education expenses. If you use money from a 529 Plan for non-qualified education expenses, you will owe income tax and a 10 percent penalty on some, but not all, of the amount you withdrew.
A withdrawal from a 529 Plan consists of two parts: contributions and earnings (provided the account value exceeds the amount of contributions). You only pay tax and penalties on the earnings part.
Let's say you own a 529 Plan and over the years have contributed a total of $30,000. Today the plan is worth $50,000 and you withdraw it all for non-qualified expenses (e.g., down payment on a house). 60 percent of the withdrawal amount is a return of principal so you only pay tax and penalty on the other 40percent ($20,000 of the $50,000), which represents the earnings in the account.
Although not usually recommended, using a 529 plan for "off-label" use (purposes other than qualified education expenses) can sometimes make sense, just like when your doctor prescribes a medication for a condition other than what that medication was originally intended for.
This makes sense for you because you have an opportunity to purchase a new home at a good price today, and if you wait, the opportunity could never come again. You said you are in a 33 percent combined federal and state tax bracket, you have a secure job, and all of your savings, which total $50,000, are in a fully taxable retirement account.
You have a choice of taking the $50,000 you need from your 529 Plan or your retirement account. If you choose to take the money from the 529 Plan, you will pay $6,600 in taxes and $2,000 in penalties for a total of $8,600. On the other hand, if you take the money from your IRA, you will pay $16,500 in taxes.

Q: If I withdraw money from my IRA account to pay for my daughter's college, can I avoid paying a penalty? I am 49 years old.
A: Yes. You can use IRA money without paying the normal 10 percent penalty to pay for qualified higher education expenses for yourself, your spouse, your children, and your grandchildren.
Qualified education expenses include tuition, fees, books, supplies, equipment, and computer and internet service if required for the enrollment or attendance at an eligible education institution. If the student is at least a half-time student, you can also deduct room and board expenses.

Kenneth B. Petersen is an investment adviser and principal of Monterey Private Wealth, Inc., in Monterey. Send questions concerning investing, retirement or estate planning to 2340 Garden Road, Suite 202, Monterey 93940 or en@priwm.com.
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