For any non-qualified disbursement, any taxes or fees are ONLY on the earnings portion.
Original contribution amounts always come out totally tax-free. Account disbursements which are non-qualified require payment of taxes on investment gains only. Federal and state taxes are owed, as well as an additional tax penalty of 10% on the earnings. This penalty may be waived in the case of death, disability, or scholarship of the designated beneficiary.
Each state plan has various types of distributions that require recapture. Some require paying back state deducted/credited amounts for K-12 expenses (11 states, including New York and New Jersey) or Roth IRA Rollovers (Indiana).
However, these taxes are a relatively small price to pay for the 529 account tax-free growth and lower fee funds. The 3.8% federal net investment income tax (NIIT) is also not applicable to 529 account growth. There are no required distributions at any age.
Job contributes $20,000 to his child’s 529 account which gains another $5,000 before Job loses his employment, home, and all his other money. He sadly needs a large non-qualified disbursement of $12,500 (½ the account value) from the now $25,000 account to live on. He will be taxed on the $2,500 growth (½ the account earnings) only. Because of his financial misfortune this year, Job is now in a lower 12% tax bracket with state tax of 3%. A 10% penalty ($250), 12% federal ($300), and 3% state ($75) tax is the most he might pay, still allowing him to keep 95% ($11,875) of his withdrawal.
No statement or example on this site should be considered a specific recommendation for your personal situation. Investing and tax strategies each carry significant risks. Examples herein may not apply to your situation. Please consult your estate attorney, tax advisor, or financial advisor for personal advice.