By: Sean Gallagher, CFP®
A 529 plan is a powerful tool designed to help families save for future education expenses. The primary allure of a 529 plan lies in its tax benefits—some states allow state-tax deductions or credits on account contributions, and the investments in the account grow tax-free. Withdrawals from 529 plans are tax-free if used for qualified educational expenses, including tuition, room and board, books and supplies, private elementary and secondary school education, and student loan repayments.
However, there are instances where families find themselves with unused funds in their 529 plans. This can happen for several reasons, such as beneficiaries attending less expensive schools than anticipated, receiving scholarships that cover most of their educational expenses, or choosing alternative educational paths like trade schools or entering the workforce directly. As a result, these overfunded accounts need to be addressed to maximize the value of the savings. Here are several strategies for managing unused 529 plan funds effectively.
Changing the Beneficiary
One of the most flexible features of a 529 plan is the ability to change the beneficiary. If the original beneficiary doesn’t need the funds, the account owner can transfer the plan to another eligible family member without incurring taxes or penalties. Eligible family members include siblings, cousins, parents, spouses, and even the account owner if they plan to pursue further education. This option ensures that the funds continue to serve their intended purpose—supporting educational endeavors within the family. However, if the beneficiary is aware of these funds, transferring the balance to a family member may create conflict within the family.
Rolling Over to a Roth IRA
Beginning in 2024, the SECURE Act 2.0 introduced a new option: rolling over unused 529 plan funds into a Roth IRA for the beneficiary. This provision is designed to provide more flexibility and to help families repurpose unused education funds for retirement savings. There are some key conditions to be aware of:
Contribution Limits: The annual rollover amount is subject to Roth IRA contribution limits of $7,000 for 2024 (plus an additional $1,000 catch-up contribution for those aged 50 and over).
Lifetime Cap: The total lifetime rollover amount is capped at $35,000 per beneficiary.
Account Age Requirement: The 529 plan must have been open for at least 15 years.
Contribution Age: Contributions made in the last five years are not eligible for rollover.
This option provides a tax-efficient way to convert unused education savings into retirement funds, benefiting the beneficiary in the long term.
Using Funds for Graduate School
If the original beneficiary decides to pursue further education, such as graduate school, law school, or medical school, the 529 plan funds can cover these expenses. Graduate programs often come with higher tuition fees, and having a 529 plan dedicated to these costs can significantly reduce the financial burden.
Funding Apprenticeships
Beneficiaries opting for vocational training over traditional college education can now use 529 plan funds for registered apprenticeship programs. These programs must be certified by the Secretary of Labor under the National Apprenticeship Act. The funds can cover fees, books, supplies, and equipment required for the apprenticeship. This expansion acknowledges the growing importance of skilled trades and provides a pathway for 529 plan funds to support practical and specific career-oriented education.
Withdrawing the Funds
Finally, there is the option of withdrawing the unused funds. However, this should be considered a last resort due to the financial implications. Non-qualified withdrawals are subject to income tax on the earnings portion and a 10% penalty. There are exceptions to this penalty, such as if the beneficiary receives a scholarship, attends a U.S. Military Academy, dies, or becomes disabled. The 10% penalty is waived in these cases, though taxes on the earnings still apply.
Withdrawing the funds can be an option if the family anticipates no other educational needs, but it’s essential to weigh the tax consequences carefully.
Conclusion
Unused 529 plan funds do not have to be a source of stress or financial waste. With several flexible options available, families can repurpose these savings in a way that continues to benefit their educational and financial goals. Whether changing the beneficiary, rolling over to a Roth IRA, using the funds for graduate school or apprenticeships, or even withdrawing the funds carefully, the key is to explore all available avenues. By doing so, families can ensure that their investment in a 529 plan continues to provide value, supporting education and beyond.
Sean Gallagher is a CERTIFIED FINANCIAL PLANNER™ at HIGHLAND Financial Advisors, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, and investment management. Sean graduated from Virginia Tech’s financial planning program in 2018 and successfully passed the CFP® national exam in 2019. As a Financial Planner at HIGHLAND Financial Advisors, Sean works on developing comprehensive financial plans and investment management for all clients.