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Will Unspent Funds in a 529 Go to Waste?

MP900448491This was something you didn’t expect—money that you didn’t spend sitting in a 529 account! If the funds are used for nonqualified expenses, you’ll get hit with taxes plus a 10% penalty on any withdrawals. What should you do?

There are a number of ways to use up those extra funds in a 529 account, according to a recent article from Los Altos Online, “How to use up leftover money in a 529 college savings plan.” The money can be used and you won’t have to worry about the taxes or penalties. Consider these options:

Graduate school. If your child is interested in an advanced degree, the money can be used tax free, just as it was for college. Any school that gets financial aid qualifies.

Another child. You can change the beneficiary of the 529 plan to another qualifying family member, without any tax implications. If you have other children, the funds can be used to pay for their qualified expenses—even if you have other 529 plans for them. Money in 529 plans can now also be used for elementary and secondary education.

Another relative. You can change the beneficiary to parents, aunts, uncles, nieces, nephews, stepparents and even first cousins. There’s no deadline for using the funds, so you can keep it as a gift for a future grandchild. However, avoid skipping a generation, because that could trigger a tax penalty.

Your own or your spouse’s career. If you’re interested in changing your career or just want to get a new degree in retirement, using leftover 529 funds will let you avoid using other savings.

Estate planning. You can choose to give a 529 account to an heir. You keep control of the account until you pass away and can continue to make annual tax-free contributions up to the gift-tax exclusion amount, provided the account value doesn’t exceed the state’s maximum limit. After you die, the value isn’t counted as part of your estate for estate taxes.

Offset any scholarships. You can withdraw any amount from the 529 plan, up to the value of all scholarships and the 10% penalty is waived, even if you apply years after the scholarship was earned. The earnings are taxable, but because distributions include both earnings and contributions, only part of this will be taxed.

Take the hit and spend the money. If there’s no one else who can use the money, you might just pay the taxes and the 10% penalty and use the money, maybe as a security deposit on your child’s first apartment, or to help buy their first car. Remember that earnings are taxed at your child’s rate.

Reference: Los Altos Online (September 18, 2019) “How to use up leftover money in a 529 college savings plan”