When it's time to pay college tuition, most families are frantically trying to find ways to fill their savings gap without having to borrow. But what if you're faced with the opposite problem and you've ended up with too much money in your 529 plan? Having excess money in a college savings plan is more common than you might think. Students may end up receiving scholarships, decide to attend military school or receive unexpected 529 plan contributions from grandparents or other relatives that can leave them with more than they need to pay for college. So now what?
The good news is that you'll never lose all of the money you put in to a 529 plan, and there are even some ways to repurpose your savings to keep your account balance intact.
But before you take a withdrawal, just be sure you understand the potential consequences of your decision. Here are five common options:
1. Transfer the funds to another beneficiary.
One of the great things about 529 plans is that they allow you to change the beneficiary to another qualifying family member without tax consequences. This is a no-brainer if you have another child who will attend college, or want to help pay for niece or nephew's private K-12 education. When you're deciding on a beneficiary, just be sure to avoid skipping generations, which could trigger a tax penalty.
Parents interested in continuing their own education can even make themselves the beneficiary. Qualified 529 plan expenses include tuition and fees from most community colleges, and even some outdoor education programs. Savingforcollege.com founder, Joe Hurley made good use of his kids' leftover 529 plan savings by earning a horticulture certificate from Finger Lakes Community College. He runs Kettle Ridge farm in Victor, NY, where he produces pure maple syrup and local honey from his own bees.
2. Save the funds for future educational needs for that child.
Remember, just because your child decides not to pursue a traditional four-year degree doesn't mean you can't use your 529 plan savings. 529 plan funds can be withdrawn tax-free to pay for tuition, fees and other qualified expenses at any eligible post-secondary institution, including vocational or technical schools. If you're one of the lucky parents who's saved more than you need for a four-year degree, consider holding on to the account in case your son or daughter wants to continue on to a graduate or professional program.
3. Use the funds for future generations.
Another great benefit of 529 plans is that there is no time limit on when you have to spend your savings. This creates an opportunity for you to leave any unused money as an educational legacy to your grandchildren. What's more, your tax advisor may one day recommend you use a 529 plan as an estate-planning tool. 529 plans offer a unique opportunity since the value is removed from your taxable estate but you're able to retain control of the account. Contributions are treated as gifts for tax purposes, which means deposits up to $15,000 per individual will qualify for the annual exclusion (in 2018).
4. Take advantage of penalty-free scholarship withdrawals.
In some cases, you can take a non-qualified withdrawal without having to pay a penalty tax on the earnings, such as when the beneficiary dies, becomes disabled, attends a U.S. Military Academy or gets a scholarship. If your child gets a scholarship, you can withdraw up to the amount of the award to spend on anything you like. Keep in mind, however that you'll still have to pay income tax on any gains in the account. To avoid paying any taxes, you can save the money for future use or another beneficiary as mentioned in #1.
5. Use the money for non-qualified expenses.
If you truly have no other use for your leftover 529 plan savings, you can always take a non-qualified withdrawal. Since your contributions were made with after-tax money they will never be taxed or penalized. Any earnings on your investments, however, will be subject to income tax as well as a 10% penalty. However, unlike your Roth IRA you're not permitted to take a principal-only withdrawal from your 529 plan. Each withdrawal is made up of contributions and earnings, so if there are gains in the account you will pay taxes and a penalty on every non-qualified distribution, except for the special exceptions mentioned in #4.