What Happens If My Kid Doesn’t Use Their 529 Plan?
What happens to 529 funds if your child doesn't use them? Understand your options for these education savings.
A 529 plan is a tax-advantaged savings vehicle for qualified education expenses. These plans offer tax-deferred growth, and withdrawals are tax-free when used for eligible costs. If the designated beneficiary does not utilize the funds, account holders often wonder about the flexibility and potential consequences. This article explores options for unused 529 plan funds.
Non-Qualified Withdrawals
Taking money from a 529 plan for non-qualified education expenses is a non-qualified withdrawal. The earnings portion is subject to federal income tax, as it has grown tax-deferred within the plan.
A 10% federal tax penalty applies to the earnings portion of a non-qualified withdrawal. State income taxes may apply to the earnings, and some states might recapture previous state tax deductions or credits received for contributions.
The taxable amount is allocated proportionally between contributions (which are not taxed as they were made with after-tax dollars) and earnings. For example, if a withdrawal is 20% earnings, only that portion is subject to taxes and penalties. Account owners or beneficiaries receive IRS Form 1099-Q, reporting total distributions, including earnings and basis. The recipient of the non-qualified distribution is responsible for paying the taxes.
Exploring Alternative Uses and Beneficiaries
If the original beneficiary no longer needs the funds, consider changing the beneficiary to another eligible family member. The IRS defines “eligible family member” to include siblings, stepparents, aunts, uncles, first cousins, or the account owner. This transfer is tax-free.
Beyond traditional college expenses, 529 funds can be used for other qualified educational costs. These include up to $10,000 per year per student for K-12 tuition. Funds can also cover qualified expenses for registered apprenticeship programs, including fees, books, supplies, and required equipment, when certified by the Department of Labor.
Funds can also be used for student loan repayment. Up to $10,000 in student loan debt can be paid per beneficiary over their lifetime, plus an additional $10,000 for each of the beneficiary’s siblings. This lifetime limit applies across all 529 accounts for that individual.
Limited rollovers from 529 plans to Roth IRAs are also allowed, offering a path for unused education savings to contribute to retirement. This rollover is subject to specific conditions: the 529 account must be open for at least 15 years for the beneficiary, and funds must have been contributed at least five years prior. The rollover amount is limited to annual Roth IRA contribution limits (e.g., $7,000 for 2025) and has a lifetime cap of $35,000 per beneficiary.
Impact of Scholarships and Other Aid
If a beneficiary receives scholarships or other tax-free educational assistance, 529 funds might go unused. The scholarship amount can be withdrawn from the 529 plan without the 10% federal tax penalty.
While the 10% federal penalty is waived, the earnings portion equal to the scholarship amount is still subject to federal income tax. Tax-free growth applies only to funds used for qualified educational expenses not covered by other tax-free aid. Maintain thorough documentation of scholarship awards and other aid to substantiate penalty-free withdrawals.
Leaving Funds in the Plan
Account owners can leave funds within the 529 plan if not immediately needed. The funds continue to grow tax-deferred, increasing their value. There is no age or time limit on how long the money can remain in the plan.
This flexibility allows for future educational needs, such as graduate school, professional certifications, or a career change. Account owners can also change the beneficiary to a younger family member, passing savings to another generation. However, 529 plan funds are subject to investment risk, meaning their value can fluctuate.