Intro to 529sThat penalty doesn't sound so bad. Am I missing something?
What could be worse than the penalty is the fact that the earnings portion of a non-qualified distribution that comes back to you, the account owner, will be subject to tax as ordinary income at your tax rate. (Some 529 plans allow you to direct the withdrawal to the beneficiary, which would presumably keep it in a low tax bracket.) In addition, if you were able to deduct your original contributions on your state income tax return, you will generally have to report additional state "recapture" income.
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