Believe it or not, some families end up with leftover funds in a 529 plan when their child finishes college. A student may win a scholarship, attend a U.S. military academy, or receive unexpected gifts or inheritances from relatives, leaving them with more money than they need to pay for college. But have you ever wondered what happens to unused 529 funds? You have two options:
- Withdraw the money
- Save the unused 529 plan funds for a future use
Don’t worry; leftover 529 money is common, and you can still make the most of the funds even after graduation. Today we’ll discuss common reasons for unused 529 funds and six common strategies for spending them with minimal tax consequences.
Reasons for unused funds in a 529 savings account
You might have leftover 529 money for a few different reasons. The beneficiary may have:
- Chosen a college where tuition was cheaper than expected, such as an in-state public college or a U.S. military academy
- Passed away or developed an illness that stopped them from continuing their education
- Received a substantial scholarship
- Decided not to go to college or dropped out
- Received inheritance money from relatives
Ways to Use Leftover 529 Funds
1. Transfer the 529 plan 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 your niece or nephew’s private K-12 education. When deciding on a beneficiary, be sure not to skip generations, which could trigger a tax penalty.
Parents may even consider making themselves the beneficiary since they can use 529 plans to pay for continuing education. Qualified 529 plan expenses include tuition and fees from most universities and community colleges, and even Outward Bound wilderness and leadership courses.
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 now runs Kettle Ridge farm in Victor, NY, where he produces pure maple syrup and local honey from his bees!
2. Save the 529 plan funds for your child’s future educational needs
Remember, just because your child or grandchild decides not to pursue a traditional four-year degree, that doesn’t mean they won’t ever need them again. You might consider keeping funds in a leftover 529 plan account in case your child wants to:
- Resume college education later
- Continue to a graduate or professional program
- Change their major and pursue a different field of study
3. Use the money to make student loan payments
The SECURE Act allows families to take tax-free 529 plan distributions to pay off student loans. Both principal and interest payments toward a student loan are considered qualified education expenses. However, the portion of student loan interest paid for with tax-free 529 plan earnings is not eligible for the student loan interest deduction.
You can pay up to $10,000 in qualified student loan repayments each per 529 plan beneficiary and their siblings (brother, sister, stepsiblings). A 529 plan account owner may change the 529 plan beneficiary at any time without tax consequences.
Since there are no time limits imposed on 529 plans, the student may keep contributing to a 529 plan throughout college or after graduation and use any leftover funds to repay student loans tax-free.
4. Save the 529 plan for a grandchild
There is no time limit on when you have to spend your 529 plan savings. This creates an opportunity 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 retain control of the account. Contributions are treated as gifts for tax purposes, which means deposits up to $16,000 per individual will qualify for the annual exclusion (in 2022).
5. 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, or attends a U.S. Military Academy. Additionally, if your child gets a scholarship, you can withdraw up to the amount of the award to spend on anything you like. However, you will incur 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 above.
6. Use the 529 plan 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 distribution. Your contributions will never be taxed or penalized, since they were made with after-tax dollars. Any earnings on your investments, however, will be subject to income tax and a 10% penalty.
Unlike a Roth IRA, 529 plan account owners may not take a principal-only distribution. Each withdrawal is made up of contributions and earnings, so in most cases if there are gains in the account you will pay taxes and a 10% penalty on the earnings portion of a non-qualified withdrawal.
If you’ve worried about what to do with unused 529 funds, you can rest assured knowing you can save them for the future and even withdraw it tax-free under certain circumstances.
But if you do decide to withdraw money, make sure you check out our guide on how to withdraw 529 money first!
- What is the Penalty on an Unused 529 Plan?
- Avoid These 529 Plan Withdrawal Traps
- How to Transfer 529 Plan Funds to a Sibling?