What Happens If a 529 Is Not Used for College?

A 529 plan is a tax-advantaged savings account designed to cover future education costs. The funds grow federally tax-deferred, and withdrawals are tax-free when used for qualified education expenses. However, a beneficiary might earn a full scholarship, decide against higher education, or other circumstances may change, leaving a balance in the account. When the funds are no longer needed for their intended purpose, account owners have several options to consider, each with distinct financial consequences.

Understanding Non-Qualified Withdrawals

A non-qualified withdrawal occurs when you take money from a 529 plan for anything other than a qualified higher education expense. The amount you contributed to the plan, known as the principal, can always be withdrawn without any tax or penalty. However, the investment earnings on that principal will be subject to both ordinary income tax at the recipient’s rate and a 10% federal penalty tax.

To illustrate, imagine a 529 account with a total value of $30,000, of which $18,000 represents your contributions and $12,000 is from investment earnings. If you take a full non-qualified withdrawal of $30,000, the $18,000 principal is returned tax-free. The $12,000 in earnings would be added to your taxable income for the year and would also be subject to a $1,200 penalty. The plan administrator will issue IRS Form 1099-Q to report the distribution, and the account owner must report the taxable portion on their tax return.

Certain situations allow for the 10% federal penalty to be waived, although income taxes on the earnings portion still apply. These exceptions include the death or permanent disability of the beneficiary. The penalty is also waived if the beneficiary receives a tax-free scholarship, but only up to the amount of the scholarship award. Another exception applies if the beneficiary attends a U.S. military academy. State tax laws may have different rules.

Permitted Uses Beyond College Expenses

Instead of taking a non-qualified withdrawal and incurring penalties, account owners can repurpose the funds for other educational needs. One option is to change the beneficiary of the plan. The new beneficiary must be a “member of the family” of the original beneficiary, as defined by the IRS. This includes the beneficiary’s spouse, children, siblings, parents, nieces, nephews, and first cousins.

The scope of qualified expenses has also expanded beyond traditional college costs. Account owners can now withdraw up to $10,000 per beneficiary, per year, to pay for tuition at an elementary or secondary public, private, or religious school. This provision allows families to use the tax-advantaged savings for K-12 education without triggering federal taxes or penalties.

Funds can also be used for certain job training programs. Expenses for fees, books, supplies, and equipment required for participation in an apprenticeship program are considered qualified. To be eligible, the program must be registered and certified with the Secretary of Labor under the National Apprenticeship Act.

A portion of the 529 plan can be used to address student loan debt. A lifetime maximum of $10,000 can be withdrawn tax-free to repay qualified student loans. This can be applied to the debt of either the 529 plan beneficiary or their siblings. This provides a way to relieve some of the financial burden of student loans for the family.

Executing a Rollover to a Roth IRA

A significant development from the SECURE 2.0 Act of 2022 allows for penalty-free and tax-free rollovers from a 529 plan to a Roth IRA. This option provides a way to convert unused education savings into retirement savings for the beneficiary, but it is governed by strict eligibility rules.

The first requirement is that the 529 account must have been open for a minimum of 15 years. The rollover must be made to a Roth IRA that is in the name of the 529 plan’s beneficiary, not the account owner. This directly converts the educational asset into a personal retirement asset for the beneficiary.

There are also limitations tied to recent contributions. Any money contributed to the 529 plan within the last five years, along with the earnings on those contributions, is ineligible for the rollover. The amount that can be rolled over is subject to annual limits. The rollover amount cannot exceed the beneficiary’s earned income for that year and is also capped by the annual Roth IRA contribution limit, which for 2025 is $7,000 for individuals under 50.

Finally, there is a lifetime maximum on the total amount that can be rolled over from a 529 plan to a Roth IRA. This lifetime limit is currently set at $35,000 per beneficiary. If all these conditions are satisfied, the transfer is considered a qualified rollover. This means the beneficiary will not owe income tax or the 10% penalty on the amount moved, effectively transforming the funds into retirement savings.