My understanding is that early (nonqualified) withdrawals from a 529 plan are penalized at 10%, plus taxed over any capital gains.
Does the 10% penalty apply to capital/investment gains only, or to the cost basis (original contributions) as well?
If the 10% penalty is only imposed on capital gains, how is it determined whether the money pulled out is from the original contributions or from gains?
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The 10% penalty applies only to the earnings (capital/investment gains only).
The plan administrator is required to keep track of that. When you take a distribution, the plan will issue an IRS form 1099-Q to report on your tax return. Box 1 will have the total distribution and box 2 the earnings.
If you do not take all your money out, the amount you do take out will be prorated between earnings and basis (contributions). That is, you are not allowed to pull out your contributions, first.
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