The goal of 529 plans is to make it easier to save for college. These tax-advantaged investment accounts allow you to save and use the growth tax-free to pay for qualified educational expenses.
Like most tax-advantaged accounts, however, there are rules about how much you can contribute — and what you can pull the funds for. That can create issues if you accidentally overcontribute. That’s the situation Becky is facing after accidentally contributing $10,000 instead of $1,000 to her daughter’s 529 account.
Must Read
- Thanks to Jeff Bezos, you can now become a landlord for as little as $100 — and no, you don’t have to deal with tenants or fix freezers. Here’s how
- I’m 49 years old and have nothing saved for retirement — what should I do? Don’t panic. Here are 6 of the easiest ways you can catch up (and fast)
- Dave Ramsey warns nearly 50% of Americans are making 1 big Social Security mistake — here’s what it is and 3 simple steps to fix it ASAP
Becky’s parents gave her daughter $1,000 for her birthday and she decided she wanted to save it for school. But when Becky typed in the amount to be deposited into her daughter’s 529 account, she accidentally added an extra zero. To make matters worse, it’s more than she had in her account and it was a Sunday, so she couldn’t call the bank in hopes of reversing it.
What happens now? Will she have to pay a penalty to withdraw the overage?
How 529 accounts work
A 529 plan is a tax-advantaged investment account designed to help families save for future education costs.
Contributions are made with after-tax dollars, but the money grows tax-deferred, and, according to IRS rules, withdrawals are tax-free when used for qualified education expenses, including tuition, fees, textbooks, supplies, computers and even room and board in some cases. You can also use up to $10,000 per year for K-12 tuition (1).
Noneducational costs, such as transportation or health care, generally don’t qualify. If the withdrawal isn’t for qualified expenses, the earnings portion is usually subject to ordinary income tax plus a 10% penalty.
There are exceptions to these rules. If the child receives a scholarship, attends a military academy, becomes disabled or passes away, then the 10% penalty is waived. But in Becky’s case, none of those apply.
If Becky withdraws funds without using them for her daughter’s education, the earnings portion would be hit with a 10% penalty — but since the money won’t be in the account long, the penalty will likely be small. But technically, she can’t just pull out just the $9,000 overage.
Every 529 distribution is split between contributions (the “basis” portion) and earnings. Contributions were already taxed, so they’re not taxed again. But you can’t withdraw just the contributions — you have to take a proportional share of both contributions and earnings. Think of it like a smoothie — you can’t scoop out just the strawberries (contributions) without also getting some of the bananas (earnings).
This was an honest mistake, so is there a way to fix the problem? Becky has a few options.
Read more: Robert Kiyosaki warns of a ‘Greater Depression’ coming to the US — with millions of Americans going poor. But he says these 2 ‘easy-money’ assets will bring in ‘great wealth’. How to get in now
What to do if you overcontribute to a 529 plan
Accidentally contributing too much to a 529 plan can feel like a financial nightmare. One slip of the finger, and you could be facing tax penalties and an overdrafted account. Here are options if this happens to you.
Check with the bank
If the transfer hasn’t settled, you may be able to stop or reverse it. Banks sometimes have a short window to cancel electronic transfers, especially if you contact them quickly. Since it’s Sunday, Becky should call the bank as early as possible Monday morning.
Ask the 529 administrator to cancel it
Another option is to call the company that manages your 529 plan and ask them to cancel the transaction. Bank transfers, especially those processed through ACH (automated clearing house), typically take several business days to complete (2). If you can catch the transaction before it processes, you may be able to cancel it.
Turn off overdraft protection
Since Becky doesn’t even have $10,000 in her account, her bank may reject the transfer automatically. Disabling overdraft protection could prevent the 529 plan from pulling money that isn’t in the bank account.
Withdraw for current educational expenses
As previously mentioned, 529 accounts can be used for K-12 expenses in some cases. If your child goes to private school, for example, you can withdraw the funds against current expenses without paying the penalty.
Consider leaving the excess
While many people don’t have an extra $9,000 to spare, leaving the funds in the 529 account might make the most sense if you can’t stop the transfer before it finalizes. Becky could even stop contributing for a year or two to make up the difference — in the meantime, those funds will grow tax-free.
If you accidentally put too much in a 529 account, you do have options. The best first step is to call both the bank and the 529 plan provider as soon as possible. Acting quickly can mean the difference between a simple fix and a costly penalty.
What to read next
- How much cash do you plan to keep on hand after you retire? Here are 3 of the biggest reasons you’ll need a substantial stash of savings in retirement
- There’s still a 35% chance of a recession hitting the American economy this year — protect your retirement savings with these 5 essential money moves ASAP
- This tiny hot Costco item has skyrocketed 74% in price in under 2 years — but now the retail giant is restricting purchase. Here’s how to buy the coveted asset in bulk
- Want an extra $1,300,000 when you retire? Dave Ramsey says this 7-step plan ‘works every single time’ to kill debt, get rich in America — and that ‘anyone’ can do it
Join 200,000+ readers and get Moneywise’s best stories and exclusive interviews first — clear insights curated and delivered weekly. Subscribe now.
Article sources
We rely only on vetted sources and credible third-party reporting. For details, see our editorial ethics and guidelines.
Saving for College (1); Experian (2)
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.