4 options for leftover 529 plan money


Dear Joe,

If my grandchild's college expenses end up upon her graduation to be less than the amount in her 529 plan, what specifically are the options for using the leftover amount?

-- Frank

Dear Frank,

I'm assuming that you are the 529 account owner, which means that the decision about what to do with the leftover funds belongs to you. There are four options available.

First, you can replace the current beneficiary with another member of the beneficiary's family. You'll simply be redirecting the use of the leftover 529 money to a brother, sister, first cousin, etc. The definition of "family member" is actually quite broad and also includes the beneficiary's father, mother, aunt, uncle, and son or daughter, as well as any of their spouses.

You can even change the beneficiary to yourself or your wife. For example, you could spend the money on adult education classes at your local community college.

Your second option is to withdraw the leftover funds as a nonqualified distribution for your own noneducational use. However, you will owe ordinary federal tax along with an additional 10 percent penalty tax on the earnings portion of the distribution. You'll probably owe state income tax as well. You may be able to avoid the 10 percent penalty if you can attribute the withdrawal to tax-free scholarships received by your grandchild.

Third, you can direct your 529 plan to make the withdrawal payable to your grandchild as the beneficiary. This way, the earnings and any penalty are reported on your grandchild's tax return. He or she will then have the net amount to use for a home purchase or any other purpose.

Your final option is to do nothing. No one is forcing you to take action with respect to your 529 account just because your grandchild has graduated from college. You can simply keep the account going, taking further advantage of tax-deferred growth, and choose any of the first three options at any time in the future.

If you were to die, the successor owner named on your application will assume the decision-making authority over the account. Conceivably, the account could continue to live through several generations of beneficiaries, although you should look into the gift-tax and generation-skipping transfer tax consequences of moving the 529 money between generations.

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