How To Use Unused 529 Funds
A 529 plan is a common tax-advantaged savings vehicle used when preparing for your child’s future education expenses. This plan allows for tax-free withdrawals when used for qualified education costs. When a child finishes college, sometimes there are 529 funds left in the account. Determining what to do with these funds going forward can be difficult. However, if handled properly, some options can benefit the family and the student.
These funds do not expire, but the plan account owners will incur a 10% penalty if spent on non-education expenses. The 10% penalty only applies to the earnings portion of the account, not the original contributions. It’s hard to predict how much money a child needs for college, so having leftover 529 funds is very common. Here are some spending strategies for those unused funds while incurring minimal tax consequences.
Transfer the 529 plan funds to another beneficiary.
A huge advantage of 529 plans is that you can rename the beneficiary to another qualifying family member with no tax consequences. Parents are even allowed to name themselves as beneficiaries since funds can be used for continuing education. Qualified education expenses include tuition, books, computers, room and board, computers for college expenses only, and repayment of student loans. There are a few other qualified expenses, but these are the most common.
Use the money to make student loan payments.
The SECURE Act 2.0 allows you to direct up to $10,000 from a 529 plan toward federal or private student loan repayments. Payments towards the principal and interest are both eligible. However, the portion of student loan interest paid with the tax-free 529 funds is not eligible for the student loan interest deduction. In the grand scheme of things, the student will save way more in interest payments than they would save on tax payments with the student loan interest deduction. This tax deduction is capped at $2,500 for 2024.
Rollover up to $35,000 to a Roth IRA.
The SECURE Act 2.0 also enacted a new regulation that started January 1st, 2024, allowing unused funds to be transferred to a Roth IRA. This gives the child a huge advantage when it comes to saving for retirement. To qualify for this transfer, the account must have been opened for at least 15 years, and the amount transferred must have been in your 529 for at least five years. There is a lifetime limit transfer of $35,000. The annual Roth IRA contribution limit for 2024 is $7,000 ($8,000 if you are 50 or older). Any amount you transfer from a 529 to a Roth IRA counts towards the annual contribution limit.
Penalty-Free Scholarship Withdrawals
In some cases, you can take a non-qualified withdrawal from a 529 plan without incurring a tax penalty on the earnings. These cases include when a beneficiary passes, becomes disabled, or attends a U.S. Military Academy. In addition, if your child gets a scholarship, you can withdraw up to that scholarship amount and spend it on non-education expenses. You will incur income tax on the earnings portion of the withdrawal, but there will be no 10% penalty.
Managing leftover 529 funds can be complex because of the rules surrounding what incurs a penalty and what doesn’t. Even if the entire account wasn’t used for education, there are still some great options regarding how those funds are used and minimizing taxes in the process. Rolling the leftover funds to a Roth IRA gives the beneficiary a head start on retirement. Renaming the beneficiary of the 529 plan gives another family member a great opportunity to pay for their education without taking out loans. Even taking advantage of a penalty-free scholarship withdrawal gives the account owner some flexibility when spending the funds. Overall, having leftover 529 funds in the plan isn’t bad, but it provides other opportunities to the original beneficiary or other family members.