What Is the Penalty for Cashing Out a 529 Plan?

Cashing out a 529 plan for anything other than qualifying education expenses carries a 10% federal penalty on the earnings portion of your withdrawal, plus ordinary federal income tax on those same earnings. Your original contributions come back tax- and penalty-free because they went in with after-tax dollars. Depending on your state and your tax bracket, the total penalty for cashing out a 529 plan can eat roughly a third of the growth you’ve built up, though several exceptions can eliminate the 10% surcharge.

What the 10% Penalty Actually Applies To

The penalty is narrower than it sounds. It hits only the earnings included in the non-qualified distribution, not the full withdrawal amount and not your contributions. Section 529(c)(6) of the tax code borrows the 10% additional tax used for Coverdell accounts under Section 530(d)(4).¹²

Those earnings also get taxed as ordinary income at your regular federal rate. For 2026, that means somewhere between 10% and 37% depending on your total taxable income.³ If you’re in the 22% bracket and withdraw $10,000 in earnings, you’d owe $2,200 in income tax and a $1,000 penalty. That’s $3,200 on $10,000 of growth, before any state taxes.

How the Earnings Portion Is Calculated

You don’t get to declare that you’re only pulling out contributions. Every withdrawal is a proportional mix of basis and growth, based on the earnings ratio of the whole account.

Say the account holds $100,000, made up of $80,000 in contributions and $20,000 in earnings. The earnings ratio is 20%. Pull out $15,000, and the IRS treats $3,000 of it as earnings and $12,000 as a tax-free return of contributions.⁴ The 10% penalty and the income tax apply only to that $3,000.

Your plan tracks both figures. Your year-end statement or online portal will show total contributions and total account value, which is all you need to run the ratio before you touch the money.

State Taxes Can Add a Second Hit

Many states gave you an income tax deduction or credit when you originally contributed. When you take a non-qualified distribution, those states typically “recapture” the earlier tax break by adding the previously deducted amount back to your state taxable income for the year of the withdrawal. You’re paying back the state benefit you already collected.

Some states also charge their own percentage penalty on the earnings portion. The combined bill (federal income tax, 10% federal penalty, state recapture, and any state-level surcharge) depends on where you live and how much you deducted in prior years. This layer is where the true cost of cashing out is usually underestimated.

When the 10% Penalty Is Waived

Federal law removes the 10% penalty in specific situations. Income tax on the earnings still applies in each case; only the surcharge disappears.²

Scholarships. If the beneficiary receives a tax-free scholarship, grant, or similar award, you can withdraw up to that same dollar amount penalty-free.
Death of the beneficiary. Distributions paid to the beneficiary’s estate or made after death are exempt.
Disability. If the beneficiary becomes disabled and a physician certifies the condition is expected to be long-lasting or result in death, the penalty is waived. The IRS uses the Section 72(m)(7) definition, which requires an inability to perform substantial work.
U.S. military academy attendance. If the beneficiary attends West Point, Annapolis, the Air Force Academy, the Coast Guard Academy, or the Merchant Marine Academy, you can withdraw an amount equal to the cost of that education without the 10% surcharge.

Keep the supporting paperwork: the scholarship award letter, death certificate, physician’s certification, or academy enrollment records, depending on which exception you’re claiming.

How to Report a Non-Qualified Withdrawal

Your plan administrator sends Form 1099-Q after any year with a distribution. Box 1 shows the total withdrawal, Box 2 the earnings, and Box 3 your basis.⁵ For 2025 distributions, that form should arrive by February 2, 2026.⁴

The taxable earnings go on Schedule 1 of Form 1040 as other income. The 10% additional tax gets calculated separately on Form 5329, which you attach to the return. Both are due by the standard April 15 filing deadline.⁶

Ways to Avoid the Penalty Before You Cash Out

The penalty is easier to sidestep than to soften. A few options preserve the money without triggering federal tax at all.

Roll Unused Funds to a Roth IRA

Since 2024, leftover 529 money can move directly into a Roth IRA in the beneficiary’s name. The annual rollover is capped at the Roth IRA contribution limit, which is $7,500 for 2026.⁷ The lifetime cap is $35,000 per beneficiary. Two conditions matter: the 529 account has to have been open for at least 15 years, and contributions made in the last five years (plus their earnings) don’t qualify. The beneficiary also needs earned income in the year of the rollover.

Change the Beneficiary

You can switch the beneficiary to another qualifying family member with no tax consequences. The eligible pool is broad: siblings, parents, children, nieces, nephews, first cousins, and in-laws of the current beneficiary all count.¹ There’s no limit on how many times you can do this, and the funds stay invested and tax-deferred while you decide.

Wait

Nothing forces a 529 to be emptied. There’s no expiration and no required distribution age. If the current beneficiary is young, might return to school, or might pass the account to their own child later, holding costs nothing. Qualified expenses now include up to $10,000 in lifetime student loan repayment per beneficiary, registered apprenticeship costs, and, as of 2026, up to $20,000 per beneficiary per year for K-12 tuition and related expenses along with certain postsecondary credentialing programs.

Watch for Overlap with Education Credits

If you’re also claiming the American Opportunity Tax Credit or the Lifetime Learning Credit, the same tuition dollars can’t justify both a tax-free 529 distribution and the credit.⁸ If you double-count by accident, the overlapping portion of the 529 withdrawal becomes non-qualified, and its earnings pick up the same 10% penalty and income tax as any other cash-out.

1
Office of the Law Revision Counsel. 26 USC 529 – Qualified Tuition Programs
2
Office of the Law Revision Counsel. 26 USC 530 – Coverdell Education Savings Accounts
3
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
4
Internal Revenue Service. Topic No. 313, Qualified Tuition Programs (QTPs)
5
Internal Revenue Service. Instructions for Form 1099-Q
6
Internal Revenue Service. When to File
7
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
8
Internal Revenue Service. 529 Plans: Questions and Answers