A fear for many who fund 529 accounts is that they won't use it all for college expenses. This may cause some to avoid saving altogether or save in a less tax-preferred way. While avoiding over-funding a 529 is an important financial planning goal, if you do end up saving more than needed there are options to access the money to reduce or avoid taxes and penalties.
Options for extra money in a 529:
All parents want the best for their kids. For many, this includes obtaining a college education. However, life is uncertain, especially when it comes to planning for a child beginning before they learn to read. For some, college is not the right path, and instead learning a trade and foregoing a formal classroom setting might be their best option. Others may take advantage of a military program, or other scholarships, and not need to pay for college at all. If you find your child in one of these, or many other, situations don't cash out their 529 without first reviewing your other options for using the funds.
1) Change the beneficiary on the account:
For most parents the problem is not over-funding college saving plan accounts, but not saving enough. As financial advisors we often see parents with multiple children open a 529 plan for each understanding that they will save as much as they can, but that there won't be enough in each plan to cover 100% of school. If one child decides not to go to college, or gets a full-ride, the funds are not lost forever, but instead can be switched to another beneficiary. The current rules of who the account can be switched to are quite broad1:
Son, daughter, stepchild, foster child, adopted child or a descendant
Siblings or step-siblings
Father or mother or ancestor of either, stepmother, stepfather
Aunt, uncle or their spouse
Niece, nephew or their spouse
First cousin or their spouse
This gives parents some flexibility to assist another child, themselves, or even help a related cousin, niece, or nephew.
2) Save the account for later
A nice financial planning feature of 529 accounts is that there is currently no time limit for when the funds need to be used. Under current law the account can be opened and funded indefinitely. Just because your child didn't use all the money for their bachelor's degree, that doesn't mean they won't go back to school in the future. The money can be left in the account to grow to either use for them at a later date, or even choose to switch the beneficiary in the future (possibly even a future grandchild!).
3) Pay back some student loans:
A recent change that came out of the SECURE Act, is that now some 529 money can be used to pay back student loans. The amount that can be used for the student is limited to $10,000. However, this $10,000 cap also applies to each of their siblings as well. As an example, if the beneficiary had a brother and sister, $10,000 each could be used to pay back student loans for all of them ($30,000 total).
4) Take advantage of an exception
There are some instances when you can withdraw money from a 529 account to avoid the 10% penalty for non-qualified expenses. While these situations will avoid the penalty, regular income tax will still be owed. However, the tax due is only calculated on the earnings, not the original contributions made to the account. There are only a few situations where this applies2:
- Scholarships/Other Assistance: If the student is a beneficiary of the 529 plan, the amount of the scholarship can be withdrawn without penalty. This is also true for other tax-free assistance like attending a Military Academy. As an example, if the student receives a $10,000 scholarship for school, $10,000 could be withdrawn for other purposes besides college expenses, although taxed at income tax rates. This would only be a good choice if there are no more future expected college expenses (as those withdrawals would be tax-free).
- Beneficiary dies or becomes disabled: Life is full of tragedies, and sometimes a child passes away or becomes disabled before they're able to attend college. In these unfortunate circumstances there is a slight tax reprieve with the 10% withdrawal penalty waived. A better option may still be to change the beneficiary to an eligible person to take advantage of tax-free withdrawals on earnings.
When it comes to college planning, with the sky-high costs of college tuition, most will not have enough saved for the entire college cost. However, for those that do, and who may have some money left over, it's important to evaluate your options before cashing out the account for good. For further questions about 529 accounts, college planning, or your financial situation in general we suggest you speak with a financial advisor.
1 https://www.savingforcollege.com/article/who-is-a-member-of-the-family-of-a-529-plan-beneficiary There may be gift tax ramifications for changing beneficiaries outside of a child.