As a parent, it's natural to want to give your children the best of everything. That means being able to pay for their education and also, being able to put a comfortable roof over their heads.
You may be in the habit of steadily funding a 529 plan for your children's schooling. These plans offer the benefit of tax-free investment gains and withdrawals on funds used to cover qualifying education expenses.
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And those expenses aren't just limited to college. You can tap a 529 plan to pay for private school at the elementary, middle, or high school level.
But if you take a 529 plan withdrawal for non-education purposes, costly penalties can apply. So if you're thinking of raiding your 529 plan to help come up with the down payment for a new home, you may want to devise an alternate plan.
Don't get penalized
If you take a non-education withdrawal from a 529 plan, you'll be penalized 10% on the gains portion of that sum. You won't be penalized on the principal portion because 529 plans are funded with after-tax dollars, just like Roth IRAs and 401(k)s.
You'll also be taxed on your gains if that money is taken for non-education purposes. So all told, using funds from a 529 plan to buy a house may not be the best move.
On the other hand, if you have money in an IRA, you can take a withdrawal of up to $10,000 without penalty to purchase a first-time home. This doesn't mean doing so is a wise choice, though.
Every dollar you remove from a retirement plan is money you won't have available during your senior years. And remember, when you withdraw funds ahead of retirement, you lose out on growth on that money, too.
The same holds true for a 529 plan. Let's say you remove a chunk of your balance years before your kids are ready for college to buy a home. In addition to taxes and penalties, you'll lose out on the chance to invest the funds you've removed. That could mean not having enough money to pay for college by the time those tuition bills start coming due.
What if you have extra money in your 529 plan?
You may be tempted to tap a 529 plan to buy a home if you wind up with excess money in your account. But if you want to avoid penalties, that won't work.
You can avoid a penalty, however, by changing the beneficiary on your 529. If you have an older child who opts out of college, you can designate a younger child of yours as the new beneficiary on that plan.
You can also, starting in 2024, roll unused 529 plan funds into a Roth IRA without penalty. In this case, you'll be subject to the annual IRA contribution limits and a lifetime rollover of $35,000 per beneficiary. But that's an option that could help ensure that your money doesn't go to waste and that you don't end up penalized.
