When changes in student circumstances result in no longer needing to use 529 plan investments to the extent originally envisioned, it’s reassuring to know you have options.
The reasons parents find themselves no longer need to fully utilize the value of their 529 account most typically relate to the student’s receipt of a full or partial scholarship, admission to a military academy, the decision to take a gap year, or change of heart altogether about pursuing higher education.
So, what are you to do if the money you saved for your child’s post-secondary education is no longer needed at this time? Relax. 529 plans have a good amount of flexibility built in and you have a number of useful options to consider.
Here’s what you need to know:
You’re in Control. Rest assured that as the 529 plan account owner, you remain in full control of your funds and in control of what to do with them if they are no longer needed for the originally intended purpose. And, you’re not locked into any one approach.
Plenty of Permitted Uses for Funds. Even if your child has received a scholarship, for instance, keep in mind there may be many other expenses that will need to be covered in the years ahead including room and board, books and supplies, and computers and related expenses like internet access.
There’s No Time Limit. Whatever the reason for your student no longer needing the savings you’ve accumulated on their behalf, you’ll be glad to know that those funds may remain invested indefinitely in your 529 plan account. And, as they grow in value, they’ll continue to do so on a tax-deferred basis.
Keeping funds invested within your 529 account provides your child with the opportunity to use them in the future for one of many forms of education they may later need or desire. Beyond this, keeping them invested enables you to think through whether you may want to use them yourself, save them for a future grandchild, or pursue another approach. The choice is always yours.
Consider Another Member of the Family. If your current beneficiary does not need all or some of the funds you’ve saved on their behalf, you may be relieved to know that with no tax consequence or penalty, you may change your beneficiary to another eligible “member of the family” of the current beneficiary and thus, transfer the funds to a 529 account for that individual’s use.
The definition of “member of the family” of the current beneficiary is quite broad and includes:
- a son or daughter, or a descendant of either,
- a stepson or stepdaughter,
- a brother, sister, stepbrother or stepsister,
- the father or mother, or an ancestor of either,
- a stepfather or stepmother,
- a son or daughter of a brother or sister,
- a brother or sister of the father or mother,
- a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law,
- the spouse of the beneficiary or of any of the other individuals listed above, or
- a first cousin.
For this purpose, a child includes a legally adopted child, and a brother or sister includes a half-brother or half-sister.
Take a Non-Qualified Withdrawal. A non-qualified withdrawal is one that is not used for an approved expense like tuition, fees, room and board, books, and supplies at an eligible institution. You may take a non-qualified withdrawal from your 529 account at any time. If the funds aren’t used for qualified higher education expenses, a federal 10% penalty tax on earnings (as well as federal and state income taxes) may apply. Non-qualified withdrawals may also be subject to an additional 2.5% California tax on earnings.
You may not, however, owe the additional 10% federal penalty on the investment earnings if the non-qualified withdrawal was taken due to receipt of a scholarship, attendance at a military academy, or due to the disability or death of the beneficiary.
Rollover to a Retirement Account for Beneficiary. Beginning in 2024, long-term 529 funds may be eligible for a direct transfer to a Roth IRA account for the benefit of the 529 plan beneficiary, without any tax consequences or penalties provided various conditions are met and the annual and aggregate distribution limitations are not exceeded. Consult your legal or tax professional for tax advice.
Keep in mind that these options and others are not mutually exclusive. Whatever approach(es) you choose to pursue, be sure to carefully review your 529 Plan Description for more detailed information about specific conditions and exceptions.