Can I Open a 529 If My Child Is in College?

It is a common misconception that 529 plans are only for parents saving for a young child’s future education. You can open and contribute to a 529 plan at any time, even if the beneficiary is already in college. While establishing an account mid-degree means you miss out on years of potential tax-free investment growth, other financial benefits can make it a worthwhile strategy. These advantages range from state tax deductions to flexible options for funds left over after graduation.

Using a 529 for Current College Costs

Once a 529 plan is funded, the money can be withdrawn tax-free for Qualified Higher Education Expenses (QHEEs) at any eligible institution. This includes colleges, universities, and vocational schools that participate in federal student aid programs. The most apparent qualified expense is tuition and mandatory fees required for enrollment.

The definition of QHEEs extends well beyond tuition to include required books, supplies, and equipment for courses. This also covers the cost of a computer, peripheral equipment, and internet access, provided they are used primarily by the student. For students attending at least half-time, room and board costs are also qualified expenses, though off-campus expenses are capped at the college’s official cost of attendance figures.

Recent rule changes allow for student loan repayment. A lifetime maximum of $10,000 per beneficiary can be withdrawn tax-free to pay the principal and interest on qualified education loans. This can be a valuable tool for a student who has already incurred debt. If you use 529 funds to pay student loan interest, you cannot also claim the student loan interest deduction for that same amount on your federal income tax return.

Financial Incentives for Late-Stage Savers

A primary reason to open a 529 plan for a student already in college is a potential state income tax benefit. Many states offer a tax deduction or credit for contributions to their specific 529 plan. This allows a parent to contribute money, claim the tax benefit, and then quickly withdraw the funds for a qualified expense, effectively creating a discount on college costs.

Even with a short time horizon, any investment earnings within the account grow on a tax-deferred basis. When the money is withdrawn for a QHEE, that growth is tax-free at the federal level and often at the state level as well. While earnings on contributions withdrawn in the same semester may be minimal, modest market gains over a year or two can add up to tax-free dollars.

A 529 plan is also treated favorably for financial aid. When owned by a parent, the assets are reported on the Free Application for Federal Student Aid (FAFSA) but are assessed at a much lower rate than assets in a student’s name. This can result in a smaller impact on eligibility for need-based financial aid compared to holding the same funds in a regular savings or brokerage account.

Managing Unused 529 Funds

If money is left in a 529 plan after graduation, you have flexible options to avoid penalties. The simplest option is to change the beneficiary to another eligible family member, such as a sibling, parent, or future grandchild, without tax consequences.

The SECURE 2.0 Act provides the option to roll over unused 529 funds into a Roth IRA for the beneficiary. This is subject to several conditions:

• The 529 account must have been open for at least 15 years.
• Contributions made in the last five years are not eligible for rollover.
• The amount rolled over annually cannot exceed the yearly Roth IRA contribution limit.
• There is a lifetime rollover maximum of $35,000 per beneficiary.

If no other qualified use for the funds exists, you can take a non-qualified withdrawal. The portion of the withdrawal from your original contributions is returned tax- and penalty-free. The earnings portion will be subject to ordinary income tax plus a 10% federal tax penalty, which may be waived if the student received a scholarship.

How to Open a 529 Plan

To open a 529 plan, you will need to gather personal information for yourself as the account owner and for the student beneficiary. This includes the full legal name, date of birth, and Social Security or Taxpayer Identification Number for each person, along with a physical address and contact information.

A primary decision is choosing which 529 plan to use. While you can enroll in almost any state’s plan, it is advantageous to research your own state’s offering. Many states provide tax deductions or credits, but often only for residents who contribute to the in-state plan.

Plans are offered in two main types: direct-sold and advisor-sold. Direct-sold plans are managed by the state, can be opened online by the individual, and they typically feature lower fees. Advisor-sold plans are purchased through a financial advisor who can provide guidance on investment choices but will come with additional fees or commissions.