What To Do With Extra 529 Money: A Strategic Guide

So, you’ve diligently saved in a 529 plan, and now you’ve got a pleasant problem: extra money. Congratulations! This means you’ve been successful in planning for education, but now you need to figure out the best way to leverage those funds. Here’s the deal: There’s no one-size-fits-all answer, but several smart strategies exist, ranging from strategic withdrawals to transferring the funds to a different beneficiary. Let’s unpack these options and help you make the best decision.

Understanding Your 529 Options

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. The earnings in the account grow tax-free, and withdrawals are also tax-free if used for qualified education expenses. But what happens when your beneficiary doesn’t need all that money? Let’s dive into the possibilities.

Strategies for Handling Excess 529 Funds

1. Change the Beneficiary

This is often the simplest and most logical solution. You can change the beneficiary to another family member without penalty. This includes siblings, children, nieces, nephews, parents, aunts, uncles, cousins, and even yourself! This makes a 529 plan a fantastic tool for multigenerational education planning. If you have other children or relatives who may pursue higher education, this is the first avenue to explore.

2. Use it for Qualified Education Expenses of Another Beneficiary

Even if you don’t formally change the beneficiary, you can use the funds for qualified education expenses of another individual. The crucial point is that the expenses must be considered “qualified.” This opens up the possibility of using the funds for graduate school, professional training, or even community college for a different family member.

3. Hold Onto It for Future Education Expenses

Education isn’t limited to traditional four-year colleges. The funds can be used for vocational schools, trade schools, or even continuing education courses. Keeping the funds invested allows them to potentially grow further, ready for any future educational opportunities.

4. Roll Over to an ABLE Account

For beneficiaries with disabilities, rolling over the excess 529 funds to an ABLE (Achieving a Better Life Experience) account is a compelling option. ABLE accounts allow individuals with disabilities to save money without jeopardizing their eligibility for certain public benefits like Supplemental Security Income (SSI) and Medicaid. There are limitations on the amount that can be rolled over annually (generally, the annual gift tax exclusion amount), but it’s a powerful tool for supporting a disabled individual’s long-term financial well-being.

5. Use it for K-12 Tuition (Limited)

The Tax Cuts and Jobs Act of 2017 expanded the definition of “qualified education expenses” to include tuition for K-12 schools, up to a limit of $10,000 per student per year. However, this can be a complex area as state laws vary significantly. Some states offer a state tax deduction for 529 contributions, and using the funds for K-12 tuition might trigger a “recapture” of those previously claimed deductions. Check your state’s specific rules before proceeding.

6. Take a Non-Qualified Withdrawal

This is generally considered the least desirable option, but it’s still an option. Taking a non-qualified withdrawal means the earnings portion of the withdrawal will be subject to both income tax and a 10% penalty. Only consider this if all other options are exhausted. Before proceeding, assess the tax implications carefully. Consult with a tax advisor to understand the impact on your overall financial situation.

7. Gift the Money (Indirectly)

While you can’t directly gift the 529 account to someone outside the permitted family relations (defined when changing the beneficiary), you can change the beneficiary to a qualifying family member and then that family member could use the money for the education expenses of someone outside the family. This is a more complicated approach, and consulting a financial advisor is highly recommended.

Factors to Consider Before Making a Decision

Before you make any decisions about your excess 529 funds, consider these factors:

• Tax implications: Understand the potential tax consequences of each option, particularly non-qualified withdrawals.
• State laws: State laws governing 529 plans vary. Make sure you know the rules in your state, including any potential recapture of tax deductions.
• Family needs: Assess the educational needs of your entire family and determine where the funds can be used most effectively.
• Investment horizon: How long until the funds are likely to be needed? This will influence your investment strategy.
• Your risk tolerance: Make sure the investment strategy within the 529 plan aligns with your comfort level.

Seeking Professional Advice

Navigating the complexities of 529 plans and tax implications can be daunting. Consult with a qualified financial advisor and/or a tax professional to get personalized advice tailored to your specific circumstances. They can help you weigh the pros and cons of each option and make the best decision for your family’s financial future.

Frequently Asked Questions (FAQs)

1. What exactly are “qualified education expenses” for a 529 plan?

Qualified education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. Room and board also qualify, subject to certain limitations (typically the school’s cost of attendance). For K-12 expenses, it’s limited to tuition only.

2. Can I use 529 funds for student loan repayment?

Yes, the SECURE Act allows you to use up to $10,000 in 529 funds to repay student loans for the beneficiary or their siblings. This is a lifetime limit, not an annual one.

3. What happens if the beneficiary receives a scholarship?

If the beneficiary receives a scholarship, you can withdraw an equivalent amount from the 529 plan without penalty. However, the earnings portion of the withdrawal will still be subject to income tax.

4. Can I transfer funds from one 529 plan to another?

Yes, you can transfer funds from one 529 plan to another without penalty or tax implications. This can be useful if you want to take advantage of lower fees, different investment options, or better customer service offered by another plan.

5. Is there a time limit for using 529 funds?

Generally, there is no age limit or a time limit on when the beneficiary can use the funds, however, each state plan may have their own specific rules. The funds can remain invested indefinitely, potentially growing for future educational expenses.

6. What are the tax implications of changing the beneficiary?

Changing the beneficiary to a qualifying family member is generally tax-free. However, if you change the beneficiary to someone who is not a qualifying family member, it could be considered a non-qualified withdrawal and subject to income tax and penalty on the earnings.

7. How often can I change the investments within my 529 plan?

The IRS allows you to change the investment options within your 529 plan twice per calendar year. However, some plans may have more restrictive rules. Check the plan documents for specific details.

8. Are contributions to a 529 plan tax-deductible at the federal level?

No, contributions to a 529 plan are not tax-deductible at the federal level. However, many states offer state income tax deductions or credits for contributions to their own 529 plans.

9. How does a 529 plan affect financial aid eligibility?

A 529 plan is considered an asset of the parent (if the parent owns the account) on the Free Application for Federal Student Aid (FAFSA). This generally has a minimal impact on financial aid eligibility, as only a small percentage of parental assets are considered available for college expenses. If owned by a dependent student or someone other than the parent (e.g., a grandparent), it is generally not reported as an asset on the FAFSA.

10. Can I use 529 funds for apprenticeship programs?

Yes, qualified apprenticeship programs that are registered and certified with the Secretary of Labor are considered qualified education expenses for 529 plans. This expands the options for vocational training.

11. What happens to the 529 plan if the beneficiary dies?

If the beneficiary dies, the funds can be transferred to another eligible family member. Alternatively, the account owner can take a non-qualified withdrawal, which would be subject to income tax and a 10% penalty on the earnings. The plan might be considered part of the beneficiary’s estate, which could have further estate tax implications.

12. How do I find a 529 plan that’s right for me?

Research different state-sponsored 529 plans and compare their fees, investment options, and historical performance. Websites like Savingforcollege.com can be a valuable resource. Also, consider whether you want to invest in your own state’s plan to potentially take advantage of state tax benefits. And, as always, seek professional financial advice to tailor the plan to your individual needs.