529 plans can be a cost-efficient way to pay for education expenses. These plans can be an attractive way to save since they offer multiple tax benefits and funds placed in the account can be invested. While some people find 529 plans and the range of incentives they offer attractive, others may be apprehensive because of the limitations. One of the main causes of concern can be what happens to unused funds. That said, there are a range of options account owners have for money that isn’t spent, which we’ll explore below.
How Do 529 Plans Work
529 plans can be used to pay for education-related expenses from kindergarten through college. While anyone is free to create an account, they’re often used by parents and grandparents planning for a child’s education. People can also open 529 plans to pay for their own college expenses. The main benefits of a 529 plan include tax-free withdrawals for qualified education expenses, state tax deductions in select states, and tax-deferred growth for money that is invested.
Funds in 529 plans are typically earmarked for education expenses which may include:
- Tuition and fees
- Room and board
- Books and supplies
- Computer and internet
- Student loans
- Apprenticeship expenses
What Happens To Unused Funds?
Not everyone ends up going the traditional college route; some may end up going to trade school or attend a local college. In other instances, students may end up getting scholarships and not need all of the money saved in a 529 plan. In both scenarios, there may be a concern about what happens to unused funds. Luckily, there are several options for what can happen to remaining funds. Additionally, funds can remain in a 529 plan indefinitely, meaning there are no time limits on when it has to be spent. Here are a few options of ways left over funds can be used.
Pass Funds to Another Beneficiary
If the initial beneficiary of a 529 plan doesn’t use up all of the funds, it’s possible to pass the money onto a new beneficiary. This could include a grandchild, sibling, or relative who may need funds for education purposes. The main thing to keep in mind is that the new beneficiary you pass the funds to has to be related to the original beneficiary.
Roll Funds Into a Roth IRA
Thanks to the Secure Act 2.0, account holders now have another option for what to do with unused 529 plan funds. They can now be rolled into a Roth IRA for the beneficiary. This may be a major incentive because it gives parents a chance to give their kids a headstart on retirement savings. There are limitations, however. For instance, there’s a lifetime limit of $35,000 meaning that’s the maximum that can be transferred from a 529 into a Roth. The account must also be owned by the beneficiary and has to have been opened for a minimum of 15 years. Additionally, conversions in any tax year are restricted to the annual IRA contribution limit, among other rules. It may be helpful to speak with a finance professional if this is an option you’re considering.
Withdraw Funds For Non-Qualified Expenses
It is possible to use funds for non-education expenses but there is a price to pay. Non-qualified withdrawals come with a 10% penalty on the earnings portion of the withdrawal from the IRS. Since the contributions are typically made with after-tax dollars, they aren’t usually penalized or taxed when you make non-qualified withdrawals. You’ll also have to pay income taxes on the earnings amount you withdraw.
For instance, let’s say you withdraw $10,000 for a non-qualified expense and of that amount, $8,000 is your initial contribution, while $2,000 is what you’ve earned as interest from investing. You’d pay income tax and a 10% penalty on those $2,000 earnings.
While it may come with a penalty, this gives account holders the option of using the money for non-education related expenses.
It’s also important to know there are exceptions for the penalty. That includes beneficiaries dying, becoming disabled, receiving tax-free scholarships, receiving education assistance through qualifying employer programs, and attending a U.S. Military among others.
Make Student Loan Payments
Beneficiaries of a 529 plan can use up to $10,000 for student loan repayments. That includes both Federal and private student loans. In addition, the funds can be used to pay up to $10,000 in student loan debt for each sibling of the beneficiary. Keep in mind this limit applies to all 529 accounts meaning if you have multiple accounts, the limit is $10,000 for all of them combined.
While it can feel risky to save lump sums of money in a 529 plan with uncertainty of what will happen in the future, there are a myriad of options for unused funds.
