Most families do not have any money leftover in their 529 college savings plan accounts. But, some do. There are several options for using the leftover money.
Although the funds in a 529 plan are earmarked for educational expenses, there are several options … [+]
Reasons for Leftover Money in a 529 Plan Account
There are several reasons why a family might have leftover money in a 529 college savings plan account.
- The family may have saved more than what they needed to pay for college.
- The student may have enrolled in a low-cost college, such as an in-state public college or one of the six-dozen colleges with generous “no loans” financial aid policies.
- The student enrolled in a U.S. military academy, where most college costs are paid by the federal government.
- The student won a big scholarship or received employer-paid educational assistance.
- The student didn’t go to college or dropped out of college.
- The student died or became disabled.
Options for Using the Leftover 529 Plan Money
If there is leftover money in a 529 plan, you can change the beneficiary to a relative of the current beneficiary. Relatives include brothers, sisters, parents, grandparents, aunts, uncles, cousins, nieces, nephews, children, descendants, and their spouses.
You can rollover funds from a 529 plan to the 529 plan of a sibling or another relative’s 529 plan or ABLE account.
There’s no need to take a distribution, as there are no age limits or time limits on distributions. You can just leave the money in the 529 plan. Since the beneficiary can be changed to the beneficiary’s children, grandchildren and other descendants, a 529 plan can be a great way of leaving a legacy for future generations.
The 529 plan will continue to earn money, even after the 529 plan account balance reaches the aggregate contribution limit.
Perhaps the child will decide to go back to college later. A 529 plan can be used to pay for graduate school, as well as continuing education expenses, not just undergraduate school. The beneficiary does not need to be degree-seeking.
A 529 plan can be used to repay student loans of the beneficiary and the beneficiary’s siblings. If the account owner changes the beneficiary to a parent, the 529 plan can also be used to repay parent loans. There is a $10,000 lifetime limit per borrower that applies in aggregate across all 529 plans. This will most often be useful when an older sibling graduated from college several years ago and still has student loans from their own education.
The last option is to take a non-qualified distribution.
Non-Qualified Distributions from A 529 Plan
The earnings portion of a non-qualified distribution is taxable at the recipient’s rate, plus a 10% tax penalty.
There may also be recapture of state income tax breaks to the extent that they are attributable to the non-qualified distribution.
Recipients of a 529 plan distribution can include the beneficiary, the account owner and a college attended by the beneficiary. If payment is made to a college, a non-qualified distribution will be taxable to the beneficiary, not the account owner.
Usually, it will be better to have the beneficiary be the recipient, since the beneficiary will often be in a lower tax bracket.
Earnings are included in a distribution proportionally. One cannot take a distribution of just the contributions, unlike a Roth IRA.
If there are several 529 plans, take a non-qualified distribution from the 529 plan with the lowest percentage earnings, since the taxes and tax penalty are based on just the earnings portion of the non-qualified distribution, not the full distribution amount.
The Tax Penalty Can Be Waived
The tax penalty will be waived in certain situations.
- If a distribution is non-qualified because the beneficiary received tax-free educational assistance, such as a scholarship, veterans’ educational assistance or employer-paid educational assistance, the tax penalty will be waived on the non-qualified distribution up to the amount of the tax-free educational assistance.
- If the distribution is non-qualified because the beneficiary attended a military academy, up to the cost of education at a military academy, as defined in 10 USC 2005(d)(3).
- If the distribution is non-qualified because of coordination restrictions with the American Opportunity Tax Credit (AOTC) or Lifetime Learning Tax Credit (LLTC), up to the amount of the expenses that were used to justify the education tax credits.
- The beneficiary dies or becomes disabled.
If the tax penalty is waived, investing in a 529 plan is no worse than investing in a taxable account.
Can You Donate the Leftover 529 Plan Money to Charity?
There is no special provision to allow account owners to donate leftover 529 plan funds to charity. So, to donate the funds to charity, the account owner must take a non-qualified distribution and pay taxes and a tax penalty on the earnings portion of the distribution.