Congratulations—your child has been accepted into college! As you prepare for this exciting transition, it is likely that you have been saving for some time, and now you are ready to start withdrawing from your college savings account(s).

Consider the Tax Implications of Withdrawals from College Savings Accounts

It is important to understand the benefits and limitations of each college savings vehicle in order to prioritize its use based on financial aid or tax considerations. Below, we’ve provided a brief introduction to some examples of savings vehicles, and encourage you to continue the conversation with your tax professional and Financial Advisor to get more information.

Section 529 Plans

Withdrawals are not subject to federal tax when used for qualified education expenses. Funds can only be used to pay for the beneficiary’s qualified education expenses. Funds can only be used to pay for the beneficiary’s qualified K–12 (up to $10,000) and higher education expenses, including tuition, mandatory fees, room and board, books, supplies, and equipment (including computers). If money is withdrawn for other purposes, the earnings withdrawn will incur federal income tax as well as a 10% penalty. You may also owe state taxes if you claimed a deduction or credit for your contributions.

Custodial Accounts (UGMA or UTMA Accounts)

Since the minor child is considered the owner, any taxable income and capital gains as a result of withdrawals are taxed to the child. Custodianship terminates when the minor reaches the age of majority under state law (generally between 18 and 21). At this time, the account terminates and the child gains full control of all the assets in the account and is taxed under their own tax rate.

A Coverdell Education Savings Account (Coverdell ESA)

The earnings on this account grow tax deferred and the money withdrawn to pay for qualified education expenses is tax exempt. If the money isn’t used for K-12 or college expenses (a nonqualified withdrawal), the earnings portion of the withdrawal will be taxed at the beneficiary’s tax rate and subject to a 10% federal penalty. In addition, the beneficiary assumes control of the account at the age of majority, which, as previously mentioned, ranges from18 to 21 depending on the state of residence.

Analyze Your Financial Aid Eligibility on an Annual Basis

A major factor in qualifying for financial aid is the amount of assets the family can contribute to the student’s college tuition each year; this is called the Expected Family Contribution (EFC). Custodial parents are expected to use up to 5.64% of their available assets each year to pay for college. Children, on the other hand, are expected to contribute 20% of the asset they own each year to pay for college.

Income also factors into the Expected Family Contribution (EFC), and will impact your child’s ability to qualify for financial aid. The financial aid application requires the income reported on your tax returns from two years prior. For example, on the 2022-2023 application, you will report your 2020 income and tax information, rather than 2021 income and tax information.

Note: Qualified distributions from a 529 plan are excluded from income if the account is owned by the parent. This exclusion provides 529 plans with an advantage over other taxable investment accounts that must be tapped for college.

A Closer Look at 529 Plans

Financial Aid Implications

From a financial aid point of view, assets held in a minor’s name count more heavily against financial aid eligibility than do the parents’ assets or assets held in a 529 plan account. A 529 in the parents name can reduce the need-based financial aid by 5.64% of the 529’s value. Student assets in an UGMA or UTMA account reduce eligibility for need-based financial aid by 20% or 25% of the asset value, as well as gift amount reducing financial aid by 50% for those applying the following year. In addition, a custodial account doesn’t have the same tax advantages as a 529 plan account. 529s also offer parents more control, including the ability to change the account beneficiary.

A grandparent-owned 529 account is not included as an asset on the FAFSA. However, any distribution to pay for college could have a major impact on the student’s financial aid eligibility. A withdrawal from the grandparent’s 529 account to pay for college could reduce the student’s financial aid by 50% because the withdrawal is counted as income to the student the next time a FAFSA is filed for financial aid.

529s compared to other savings strategies:

  • A 529 in the parents name has a low availability rate – up to 5.64%
  • A gift into a UGMA account could have a detrimental effect due to assets being counted (20 or 25% depending on the app), as well as gift amount reducing financial aid by 50% for those applying the following year
  • Paying tuition outright would not have a detrimental effect if the student only has one or two years left in school, otherwise would reduce eligibility by 50% the following year
  • A Roth IRA contribution for any child with their own earned income is a possibility; it can be used for retirement savings if not for college, but the withdrawals will reduce eligibility by 50% as well. This is similar to a 529, but would not have state tax benefits, is limited to earned income or 6k/year contributions, but 0% availability on FAFSA

Develop an Appropriate Spend-Down Strategy

Evaluating which college savings vehicle to withdraw from first is vital and should be considered on a case-by-case basis.

  • Families may want to consider spending down the child’s assets first before the parent’s assets, due to the child’s assets contributing to a potentially less favorable consideration for financial aid. If financial aid eligibility is a concern, it may be beneficial to start the withdrawals from the custodial account in order to take advantage of the kiddie tax exemption amount of $2,300, and use these proceeds to cover education costs. You can also employ alternative strategies to help to minimize your tax liability, such as selecting investments with lower yield income than $2,300 (dividend and capital gains distributions) on an annual basis. Lastly, you can sell investments from the account with current investment losses or gains of less than $2,300 and use that to fund college expenses. 
  • If there is no financial aid to consider, you may want to delay using assets in an UGMA/UTMA account and potentially use tax-advantaged distributions from a 529 plan or Coverdell ESA, since UGMA/UTMA accounts eventually become the asset of the student once they reach the age of majority. At that time, the student will likely be in a lower tax bracket, and the funds will be eligible for any expenses, not just college. Many parents of college-aged children find that it can be beneficial to use your 529 Plan or Coverdell Education Savings Account for qualified expenses, followed by any custodial accounts for non-qualified expenses.
  • If you hold multiple 529 college savings accounts, you can help maximize your savings by organizing the distribution of your savings. It may be best to spend from the account with the greatest appreciation to lock in gains and utilize the tax-free benefit toward qualified higher education expenses.
  • Spending more of your 529 assets in the earlier years of college can increase the student’s financial aid eligibility in later years and reduce the amount of interest that will accrue on any unsubsidized loans obtained while the child is enrolled in school. Depending on your situation, allocating your 529 savings in small increments throughout each year of college may be a less than optimal strategy because the college savings will reduce eligibility for need-based aid during the freshman year and each subsequent year.
  • If the student is a beneficiary of a 529 plan owned by a non-parent relative (i.e., a grandparent), you may consider redirecting the ownership to the parent prior to the financial aid filing year. This allows the account to have less of an effect on the EFC asset testing calculation, versus a distribution reported on the income test for the minor. If you are not able to change the ownership, consider using the 529 plan assets from non-parent relatives in the later years of college.
  • If you are utilizing non-qualified assets, you may also consider avoiding distributing highly appreciated positions with large capital gains to prevent a potential increase in your adjusted gross income (AGI).

In most cases, it is not recommended to take withdrawals from your qualified retirement accounts to pay for college due to the taxes and early withdrawal penalties that could be incurred. There are other options if your college savings come up short (i.e., student loans or scholarship applications), but there are no loans for retirement!

Working With Janney

Depending on your financial needs and personal preferences, you may opt to engage in a brokerage relationship, an advisory relationship or a combination of both. Each time you open an account, we will make recommendations on which type of relationship is in your best interest based on the information you provide when you complete or update your client profile.

When you engage in an advisory relationship, you will pay an asset-based fee which encompasses, among other things, a defined investment strategy, ongoing monitoring, and performance reporting. Your Financial Advisor will serve in a fiduciary capacity for your advisory accounts.

For more information about Janney, please see Janney’s Relationship Summary (Form CRS) on which details all material facts about the scope and terms of our relationship with you and any potential conflicts of interest.

By establishing a relationship with a Janney Financial Advisor, we can build a tailored financial plan and make recommendations about solutions that are aligned with your best interest and unique needs, goals, and preferences.

Contact us today to discuss how we can put a plan in place designed to help you reach your financial goals.

This is for informative purposes only and in no event should be construed as a representation by us or as an offer to sell, or solicitation of an offer to buy any securities. The factual information given herein is taken from sources that we believe to be reliable, but is not guaranteed by us as to accuracy or completeness. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. Employees of Janney Montgomery Scott LLC or its affiliates may, at times, release written or oral commentary, technical analysis, or trading strategies that differ from the opinions expressed within.


Janney Montgomery Scott LLC, its affiliates, and its employees are not in the business of providing tax, regulatory, accounting, or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any taxpayer for the purpose of avoiding tax penalties. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.

About the author

Shurdonna Joseph

Vice President & Director, High Net Worth Consulting

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