6 ways to spend leftover 529 plan money

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Kathryn Flynn

By Kathryn Flynn

February 25, 2019

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, decide to attend a U.S. military or receive unexpected gifts or inheritances from relatives, leaving them with more money than they need to pay for college. Families have the option to take a withdrawal or save the excess 529 plan funds for a future use.

Here are six common strategies for spending leftover 529 plan money, and how to minimize the potential consequences of each: 

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 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 may even consider making themselves the beneficiary, since 529 plans can also be used to pay for continuing education. 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 now runs Kettle Ridge farm in Victor, NY, where he produces pure maple syrup and local honey from his own bees.

2. Save the 529 plan funds for your child’s future educational needs

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not to pursue a traditional four-year degree doesn’t mean you can’t use your 529 plan savings. 529 plan funds can be withdrawn tax-free to pay for tuition, fees and other qualified expenses at any eligible post-secondary institution, including vocational or technical schools. You may also consider keeping funds in a leftover 529 plan account in case your son or daughter wants to continue on to a graduate or professional program. 

3. Use the money to make student loan payments 

The SECURE Act allows families to take tax-free 529 plan distributions for student loan repayment. Principal and interest payments toward a qualified education loan will be considered qualified 529 plan expenses. The portion of student loan interest that is paid for with tax-free 529 plan earnings is not eligible for the student loan interest deduction.

The law includes an aggregate lifetime limit of $10,000 in qualified student loan repayments per 529 plan beneficiary and $10,000 per each of the beneficiary’s siblings. Siblings may include a brother, sister, stepbrother or stepsister. 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 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 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 2019). 

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, 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 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 as well as 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.

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Upromise is a program that allows you to earn cash back to your 529 plan by simply shopping through their online portal, dining out, or signing up for their cash back credit card. CollegeBacker also has a cash back shopping portal, as well as an easy to use gifting page for family and friends to make a contribution to your child’s college fund. 

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