What Happens to 529 If Your Child Gets a Scholarship?

If your child gets a scholarship, the money in the 529 plan is not stuck and it is not forfeited. Federal law lets you withdraw up to the scholarship amount without the usual 10 percent penalty on earnings, and you have several other ways to keep the account working: spend it on qualified costs the scholarship does not cover, change the beneficiary to another family member, or roll leftover funds into a Roth IRA for the student.

The Scholarship Penalty Exception

A non-qualified withdrawal from a 529 normally triggers a 10 percent additional tax on the earnings portion of the distribution.¹ When the beneficiary receives a scholarship, federal law waives that penalty on a withdrawal up to the dollar value of the scholarship.² A $15,000 scholarship lets you pull out up to $15,000 penalty-free. Anything beyond that amount taken as a non-qualified withdrawal still owes the 10 percent penalty on its earnings share.

The waiver is not limited to academic scholarships. It also covers veterans’ educational assistance, employer-provided tuition benefits, and other tax-free educational payments, using the same dollar-for-dollar limit.³

Taxes You Still Owe

Skipping the penalty is not the same as taking the money tax-free. Ordinary federal income tax still applies to the earnings portion of the distribution. Your original contributions come back untaxed because you funded the account with after-tax dollars. Only the investment growth counts as income.

The taxable share follows the ratio of earnings to total account value. If gains make up 25 percent of the account, 25 percent of the withdrawal is taxable. That income is taxed at the recipient’s regular federal rate.⁴ Sending the distribution directly to the student instead of the account owner puts the earnings on the student’s tax return, where the rate is often lower.

Spend It on Costs the Scholarship Does Not Cover

Before pulling cash out, look at what the scholarship actually pays for. A scholarship that covers tuition rarely covers everything, and 529 money used on qualified expenses avoids both the penalty and the income tax on earnings. That is the best tax outcome available.

Qualified higher education expenses include tuition, required fees, books, supplies, and equipment. Computers, software, and internet access qualify if the student uses them primarily for school. Special needs services tied to enrollment count too.²

Room and board qualify for students enrolled at least half-time. Off-campus housing is capped at the school’s published cost-of-attendance figure for room and board. On-campus students can use the greater of the cost-of-attendance figure or what the school actually charges.²

Student Loans, Apprenticeships, and K–12

If the student still borrows for other costs, up to $10,000 from the 529 can go toward qualified education loan principal or interest. That $10,000 is a lifetime cap per borrower, and the same cap applies separately to each sibling of the beneficiary.²

Fees, books, supplies, and equipment for apprenticeship programs registered with the U.S. Department of Labor also count as qualified expenses.⁵ And up to $10,000 per year can go toward tuition at a private, public, or religious elementary or secondary school, which can matter if you have younger children in the family.⁶

Coordinating With Education Tax Credits

Many families qualify for the American Opportunity Tax Credit or the Lifetime Learning Credit in the same year they take a 529 distribution. You can claim a credit and take a tax-free 529 distribution the same year, but the same dollar of expense cannot support both.³ If tuition runs $20,000, you might steer $4,000 toward the American Opportunity Credit (worth up to $2,500) and use 529 funds for the other $16,000. The split often saves more than paying the whole bill from the 529.

When you calculate the tax-free share of the 529 distribution, first subtract any tax-free educational assistance (including the scholarship itself) from qualified expenses, then subtract the expenses used for the credit.³ Double-count expenses and part of the 529 distribution becomes taxable.

Change the Beneficiary

If the scholarship recipient has no use for the remaining balance, transfer the account to another family member with no tax consequences. The IRS defines family broadly for this purpose: siblings, step-siblings, parents, children, first cousins, nieces, nephews, aunts, uncles, and the spouses of any of them.² The account owner can even name themselves the new beneficiary to fund their own further education. The money keeps compounding inside the tax-advantaged account. Most plan administrators handle the change with a single form.

Roll Leftover Funds Into a Roth IRA

Since 2024, leftover 529 money can be rolled into a Roth IRA in the beneficiary’s name, turning unused education savings into retirement savings. Several conditions apply:⁷

The 529 account must have been open for more than 15 years.
Contributions made in the last five years, along with their earnings, are not eligible.
The rollover in any year cannot exceed the annual Roth IRA contribution limit, which is $7,500 for 2026, or $8,600 if the beneficiary is 50 or older.⁸
Total rollovers per beneficiary are capped at $35,000 over the beneficiary’s lifetime.
The beneficiary must have earned income at least equal to the rollover amount for the year, and the Roth IRA must be in the beneficiary’s name.

Because of the annual cap, moving the full $35,000 takes at least five years under current limits. The rollover itself carries no tax or penalty when the rules are followed.

Watch for State Tax Recapture

Many states give a deduction or credit for 529 contributions, and a scholarship-related withdrawal raises the question of whether the state will claw that benefit back. Some states explicitly exempt scholarship-based withdrawals from recapture. Others treat the earnings portion as taxable state income regardless of the federal exception. The federal penalty waiver does not automatically carry over to state rules, so check how your state handles both recapture and the taxable earnings before taking the distribution.

Reporting the Withdrawal

After a distribution, the plan administrator issues Form 1099-Q to whoever received the funds, whether that is the account owner or the beneficiary.⁹ The form shows the gross distribution, the earnings portion, and your basis. If the check went to the student, the 1099-Q comes under the student’s Social Security number and the student reports any taxable earnings.

To back up the scholarship penalty waiver, keep the scholarship award letter showing the dollar amount and the academic period it covers, proof of enrollment for that period, and the Form 1099-Q with your tax return records. The IRS does not require you to attach any of this to your return, but you will want it on hand if the return is reviewed. Keeping the scholarship letter and the 1099-Q together makes it easy to show that the penalty-free withdrawal stayed within the scholarship amount.

1
Office of the Law Revision Counsel. 26 U.S. Code 530 – Coverdell Education Savings Accounts
2
Office of the Law Revision Counsel. 26 USC 529 – Qualified Tuition Programs
3
Internal Revenue Service. Publication 970 Tax Benefits for Education
4
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
5
Internal Revenue Service. Topic No. 313, Qualified Tuition Programs (QTPs)
6
Internal Revenue Service. 529 Plans Questions and Answers
7
Internal Revenue Service. Publication 590-A (2025), Contributions to Individual Retirement Arrangements (IRAs) – Section: Can You Move Amounts Into a Roth IRA?
8
Internal Revenue Service. Retirement Topics – IRA Contribution Limits
9
Internal Revenue Service. Instructions for Form 1099-Q (Rev. April 2025)