4 options for leftover 529 plan money

By: Savingforcollege.com


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.

Popular Questions


Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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