The 529 was owned by a grandparent and when the scholarship was given, we learned we could take a penalty free distribution but only in the year of the scholarship. As the grandparent didn’t want to incur taxes for the distribution, she transferred just the amount of the fall semester scholarship into a new account set up for the dependent student. About 30K. And then that whole amount was used to pay off the parents’ loans taken out for school expenses. So the new 529 account is empty.

Assuming nothing changes in the financial aid, there will be an addtional scholarship amounts that can be taken as penalty free distributions in spring of freshman year and fall of sophomore year; we planned to make similar withdrawals and pay off loans with them again. If we didn’t have to withdraw the scholarship amounts from 529s in the year of their award in order to be penalty-free distributions, we’d wait until winter of sophomore year so as not to disrupt financial aid. But is this a mistake? What are we doing wrong here and how can we do this better?