If you’ve researched how to pay for college, you’ve likely heard of a 529 plan. A 529 plan, also known as a 529 college savings plan, is a tax-advantaged investment account primarily intended to help families save for college expenses.
You invest over time, and your earnings grow tax-deferred while in the account. When your family is ready to pay for college, you can withdraw those funds, along with any gains, tax-free, as long as the money is being used for qualified education expenses.
These accounts are a great alternative to regular savings accounts, where your money earns little interest and can even lose value over time due to inflation.
One of the most common concerns about 529 plans is, “What if I have a 529 plan, but my child doesn’t go to college?” That’s a great question. Luckily, there are plenty of ways to use your investment, even if your child doesn’t go to a traditional 4-year college. Let’s explore your options.
You Can Change Your 529 Beneficiary At Any Time
This option is pretty straightforward: you can change your 529 beneficiary. When you open a 529 plan account, you must designate a beneficiary. That’s the person whose education you’re investing for. The account owner can change the beneficiary at any time.
Let’s say you opened a 529 plan for your oldest child when they were little, and now they’ve graduated from high school and chosen not to pursue higher education. Or maybe they got a huge scholarship and don’t need any more money for school (hey, it could happen).
You can very easily change the beneficiary of the 529 plan to be another family member, like one of your younger children, and put that money toward their education. If adult learners are in your family, like you or a spouse, you could even make yourself the beneficiary.
Another idea is to leave the account exactly as it is. You don’t need to contribute anymore. Just let it grow over time. Then, someday, you can be everyone’s hero and make your grandchild the beneficiary. Wouldn’t that be an incredible gift?
But 529 beneficiaries don’t have to be in your family. You could save it for a friend or anyone. Changing a beneficiary is generally quick— you can do it all by logging into your account.
The three main criteria for 529 beneficiaries are:
- They must be a US citizen or resident.
- They must have a Social Security number or federal tax identification number.
- They must be the person whose education the account will fund.
Use 529 Funds To Pay For K-12 Education
Here’s another benefit of 529 plans. The money doesn’t have to be used only for college. There are other qualifying education expenses, too, like K-12 education. It’s no secret that K-12 education can be expensive for some people.
If you have your heart set on sending your kids to a certain private school, opening a 529 plan early on for their K-12 education is something you might want to think about (Though you would want to consider your shorter time horizon when choosing an investment portfolio).
You can use up to $10,000 per year to cover K-12 tuition. But that’s all. It’s slightly different from using a 529 account to pay for college expenses. In this case, books, supplies and equipment, computers, and room and board are not considered qualified education expenses.
Using 529 Funds to Pay for Career Training and Apprenticeship Programs
It seems like there was a decades-long period when college was touted as the best and only choice for high school students to pursue after graduation. High school counselors essentially became college counselors, and students weren’t really introduced to other opportunities.
Don’t get me wrong — college is great. For many, it’s the pathway to new experiences, a fulfilling career, and financial stability. But it’s not the only path.
If your 529 beneficiary chooses not to go to a traditional college, you can also use the education savings in your 529 to help pay for other forms of higher education, like trade schools, career training, and apprenticeship programs.
Generally, qualified higher education expenses would be the same as at a traditional college and include:
- Tuition and fees
- Textbooks
- Supplies and equipment required for enrollment or attendance at the trade school, including tools
- Special needs expenses
- Computers, internet access, and related equipment
- Room and board expenses, including on- and off-campus, as long as the student is enrolled in an eligible trade school program on at least a half-time basis and the expenses were incurred during an academic period during which the student was enrolled or accepted for enrollment in a degree or certificate program or another program leading to a recognized education credential
Kick-Start Retirement Savings and Transfer 529 Funds to a Roth IRA
Here’s something relatively new that many people still don’t know about. If your 529 beneficiary chooses not to pursue higher education (or if you don’t need to use the funds from the 529 plan for any reason), you can make tax- and penalty-free rollovers to a Roth IRA retirement plan and help get your beneficiary’s retirement savings off to an incredible start.
And if it seems like it might be too early for a recent high school grad to be saving for retirement — that’s just the point. With investing, time is your friend. Think of all the time and potential for growth that a Roth IRA account has!
The rollover amount from a 529 plan into a Roth IRA account is subject to the Roth IRA annual contribution limits set by the IRS. The annual Roth IRA contribution limit in 2024 is $7,000 ($8,000 for those aged 50 plus). There’s also a $35,000 lifetime limit per beneficiary for 529 plan rollover contributions to Roth IRAs.
While there are some time limits and restrictions around how much you can roll over, it’s an amazingly generous gift to give someone — and one that will pay off big time in the future.
Use A 529 to Pay Off Student Loans
Another alternative is to use 529 funds to help pay off student loans. Thanks to something called the SECURE Act, you can use up to $10,000 of your 529 funds to cover principal and interest payments for qualified education loans (generally, loans that were taken out specifically for education and not another purpose). This includes federal and private student loans.
Even if your 529 beneficiary doesn’t go to college, you, as the account holder, can change the beneficiary at any time. Let’s say your youngest child doesn’t pursue college or chooses a lower-cost option, and it frees up some of their 529 funds. In this case, you could change the beneficiary — even multiple times — to help pay off any financial aid your older children (or anyone else) might have taken out.
Sometimes, our plans for how we’ll pay for college change along the way. Maybe your child became someone’s 529 beneficiary late in the game after taking on some student loan debt. Using a 529 plan to help pay off student loans gives you a little more flexibility when the unexpected happens.
Withdrawing 529 Funds For Non-Educational Expenses
To be clear, 529 account holders can always withdraw their funds. However, the main benefit of these plans is that you pay no tax on your earnings when the funds are used for qualified education expenses. Making withdrawals for any other purpose is really a last resort.
If you absolutely need to make a non-qualified withdrawal for some reason, your earnings portion of that distribution will be subject to income tax, plus a 10 percent tax penalty.
It’s important to understand that your contributions to the account and the money you put into it will never be taxed or penalized since you made those contributions with after-tax dollars. So, you never really lose any of the money you put into the account. The 10 percent tax penalty is only on your earnings portion. Though it’s still a bummer, I know.
Understanding the 10 Percent Tax Penalty
Here’s an example of what that penalty could look like.
You have $7,000 in qualified expenses this year but withdrew $8,000. This leaves you with $1,000 in non-qualified expenses. In addition, your earnings portion for this distribution was $1,000. So, how much is your 529 penalty?
Here’s a basic formula you can use to calculate how much of the non-qualified expenses are subject to taxes and penalties:
Non-Taxable Part of Distribution = ((Qualified Expenses)/(Total Distribution)) x (Earnings Portion)
Let’s plug in some numbers:
$7,000 (qualified expenses)/$8,000 (total distribution)
= 0.875
0.875 x 1,000 (total earnings) = $875
So, you don’t have to pay tax on $875 of the $1,000 extra you took out. The remaining $125 is subject to income tax and the 10% withdrawal penalty.
Paying State Tax On Non-Qualified Withdrawals
Aside from the 10 percent penalty tax, you must also pay state income tax on the earnings portion of your withdrawal. Some states may even have an additional penalty tax of their own. California, for example, has a 2.5% state income tax penalty for non-qualified withdrawals.
There Are Ways To Avoid 529 Penalties
Even if your beneficiary doesn’t end up going to a traditional college or decides their best path is to attend a community college to lower their cost burden, there are still ways you can avoid non-qualified withdrawals that lead to a tax penalty — and use your 529 plan to cover qualified education expenses.
You can help your beneficiary pay for a vocational school or think ahead and help them with retirement savings. You can also help your original beneficiary’s siblings pay for college — or even their K-12 tuition.
The good news is, now that you know your options, you can still take advantage of the tax benefits 529s offer and make the personal finance decision that’s right for you.
