Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / Using 529 Plans to Cover Your Child's Wedding
Transcript
- Lucas: So Luna, I was talking to a friend over the weekend, and she mentioned she's thinking about using her daughter's 529 plan to help pay for the wedding. And I thought, wait, can you even do that? Luna: That's a great question. I've heard whispers about it, but I'm not totally clear on the rules. Is it actually allowed? Lucas: It is, with a big caveat. The SECURE Act in 2019 expanded 529 plan withdrawals to include up to ten thousand dollars for student loan repayments, but it also quietly made weddings a qualified expense in a roundabout way. Luna: Roundabout how? I thought weddings were never on the list. Lucas: Right, so the official qualified expenses are tuition, room and board, books, computers, and a few other things. But the key is this: you can change the beneficiary on a 529 plan to almost anyone in the family. So if the parent is the account owner, they can name the child as beneficiary, take a distribution, and if it's not for a qualified expense, the earnings portion is subject to income tax plus a ten percent penalty. Luna: So you're saying it's technically possible, but you'd pay a penalty on the earnings? That doesn't sound like a great deal. Lucas: Exactly. The penalty is on the earnings, not the contributions. Contributions were already taxed, so you get those back tax-free. But the growth, the investment gains, those get hit with ordinary income tax and the ten percent penalty. So it's not a tax-free wedding fund by any stretch. Luna: But I've also heard that some people use the 529 to pay for a wedding without penalty, is there a loophole? Lucas: There's no loophole, but there's a strategy. If you name the child as the beneficiary and then take a distribution for a wedding, the IRS treats it as a non-qualified withdrawal. Penalty and tax on earnings. However, if you change the beneficiary to the child's fiancé or spouse, and then use it for their education expenses, that's fine. But for the wedding itself, you're stuck with the penalty. Luna: So the only way to avoid the penalty is to use the money for actual education costs. That makes sense. But then why would anyone use a 529 for a wedding? Lucas: Because sometimes the alternative is worse. Imagine you have a 529 with fifty thousand dollars, and your kid decides not to go to college. You could leave it in there, but if you take it out for a wedding, you pay tax and penalty on the earnings. But if you're in a high tax bracket, that might still be better than taking out a loan at nine percent interest. Luna: That's a good point. It's all about the opportunity cost. And I guess for some families, a wedding is a once-in-a-lifetime expense, and they'd rather use the money for that than leave it sitting in a 529 forever. Lucas: Exactly. And the penalty is only ten percent on earnings, which is a lot less than what you might pay in credit card interest or a personal loan. So it's not crazy, but you have to run the numbers. Luna: We should probably mention that we don't run ads on this show. If you find these conversations useful and want to support the work, you can do that at buy me a coffee dot com slash fexingo. It's a small way to keep the podcast going without any sponsors. Lucas: Yeah, and we really appreciate that. It's what keeps this independent and ad-free. So thanks for considering it. Now, back to the wedding question. Let's dig into the tax math a bit more. Luna: So if you take out ten thousand dollars for a wedding, and the earnings are, say, four thousand, you'd pay ordinary income tax on that four thousand plus a four hundred dollar penalty. Is that right? Lucas: That's the gist. And the tax rate depends on your bracket. If you're in the twenty-two percent bracket, you'd pay eight hundred eighty dollars in federal tax on the earnings, plus the four hundred penalty. So you'd net about two thousand seven hundred dollars of the earnings. Not great, but not a disaster. Luna: And state taxes might apply too, right? I think some states also impose a penalty or tax on non-qualified withdrawals. Lucas: Yes, and that varies by state. Some states might recapture the state tax deduction you got on contributions. So if you live in a state that offers a state income tax deduction for 529 contributions, you might have to give that back. That could be a significant hit. Luna: So it's not just the federal penalty. You have to consider your state's rules. That's a lot of moving parts. Lucas: Right. And that's why it's so important to talk to a tax advisor before doing this. But there's another angle: you can also use a 529 to pay for a wedding if you're the beneficiary and you're getting married yourself. Some people do that if they have leftover funds. Luna: Interesting. So if you have a 529 in your own name and you decide not to go to grad school, you could use it for your wedding? But again, with the penalty. Lucas: Yeah, exactly. And there's also the gift tax angle. If you're the account owner and you take out money for a wedding, you're essentially making a gift to the couple. If the gift is more than the annual exclusion, which is eighteen thousand dollars per person in 2026, you'd have to file a gift tax return. Luna: So if you're paying for a twenty thousand dollar wedding with 529 funds, you'd have to file a gift tax return if the beneficiary isn't your dependent? Lucas: That's correct. But the gift tax return doesn't mean you owe tax, it just counts against your lifetime exemption. For most people, that's not a problem, but it's a reporting requirement you don't want to ignore. Luna: So what's the smartest way to use a 529 for a wedding if you're determined to do it? Lucas: The smartest way is to treat it as a last resort. First, see if you can use current income or other savings. If you absolutely need to dip into the 529, consider using the contributions first, since those come out tax-free. Then, if you must touch the earnings, you're only paying penalty on the growth. Luna: But how do you know which part is contributions and which is earnings? It's not like there's a separate account for each. Lucas: Right, the IRS uses a pro-rata rule. So if your 529 has a mix of contributions and earnings, each withdrawal is proportionally split. You can't just take out the contributions first. That's a common misconception. Luna: So if you have fifty thousand in the account and ten thousand is earnings, then twenty percent of any withdrawal is earnings. That means a ten thousand dollar wedding withdrawal would include two thousand in earnings, and you'd pay tax and penalty on that two thousand. Lucas: Exactly. So the penalty is on two thousand, which is two hundred dollars, plus the income tax on that two thousand. It's not as bad as you might think, but it's still a cost. Luna: And if the account has lost money, then there's no earnings to tax, so you could take out the entire amount without penalty, right? Lucas: That's a good point. If your 529 has lost value, the earnings portion could be zero, so you'd just pay income tax on the growth, which is zero. So in that case, using it for a wedding might not trigger any penalty at all. But you'd still have to prove the loss. Luna: That's a nice silver lining for people who invested aggressively and got burned. Lucas: Right. So the bottom line is: yes, you can use a 529 for a wedding, but you need to think about the tax implications. It's not a free lunch. But for some families, it's a reasonable choice if they have excess funds and no other education expenses. Luna: So what's the one thing you'd want a listener to remember from this episode? Lucas: I think it's that a 529 is really powerful for education, but once you step outside that, you lose the tax benefits. So before you use it for a wedding, run the numbers, consider your state rules, and maybe talk to a tax pro. It might still make sense, but it's not a decision to make lightly. Luna: That's a good note to end on. Thanks, Lucas. And for anyone curious about their specific situation, a quick call to a financial advisor could save you a lot of money.