Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

What penalty applies when funds are withdrawn from a 529 Plan for non-qualified education expenses?

1. 5% penalty

2. 10% penalty

3. 15% penalty

4. No penalty

The correct answer is: 10% penalty

When funds are withdrawn from a 529 Plan for non-qualified education expenses, a 10% penalty is imposed on the earnings portion of the withdrawal. This penalty serves to discourage the use of these specialized savings accounts for purposes other than education-related expenses, which include tuition, fees, books, room and board at eligible institutions, and certain other qualified costs. In addition to the 10% penalty, the earnings portion of the withdrawal is also subject to federal income tax. However, the principal amount that was contributed to the account is not subject to either the penalty or income tax, as those contributions were made with after-tax dollars. This regulation is in place to ensure that the tax advantages of 529 Plans, such as tax-free growth and tax-free withdrawals for qualified education expenses, are used appropriately and that they serve their intended purpose of promoting higher education.