What Happens to 529 Money If Not Used?

A 529 plan serves as a dedicated savings vehicle designed to help families cover future education costs. These plans offer tax advantages, allowing investments to grow tax-free and qualified withdrawals to be made without federal income tax. However, circumstances can change, and a beneficiary might not use all the funds for their intended purpose, leading to questions about the remaining balance.

Account holders often seek clarity on options for unused 529 funds. Understanding the rules governing these plans is important for maximizing their benefits and avoiding potential financial repercussions. This article will guide readers through the specifics of qualified education expenses, the tax consequences of non-qualified withdrawals, and alternative strategies for managing unused funds.

Understanding Qualified Education Expenses

For a 529 plan withdrawal to be federal income tax-free, the funds must be used for qualified education expenses. These expenses encompass a broad range of costs associated with enrollment or attendance at an eligible educational institution, which includes most accredited colleges, universities, vocational schools, and other postsecondary institutions participating in U.S. Department of Education student aid programs. Tuition and fees are primary qualified expenses, covering the direct cost of instruction.

Required books, supplies, and equipment are eligible, including computers and internet access if used primarily by the beneficiary during enrollment. Room and board costs also qualify, provided the student is enrolled at least half-time. The qualified amount for room and board cannot exceed the allowance determined by the educational institution for federal financial aid, or the actual amount charged for on-campus housing.

Recent legislative changes have expanded the scope of qualified expenses beyond traditional higher education. Funds can be used for tuition at elementary or secondary public, private, or religious schools, with a limit of up to $10,000 per beneficiary per year. Effective July 4, 2025, additional K-12 expenses, such as curriculum materials, books, tutoring, online courses, and testing fees, will also be considered qualified.

Apprenticeship programs registered and certified with the Secretary of Labor are now also eligible, covering fees, books, supplies, and equipment required for participation. Funds can also repay qualified student loans for the beneficiary or their siblings, up to a lifetime limit of $10,000 per individual, covering both principal and interest.

Tax Implications of Non-Qualified Withdrawals

When funds are withdrawn from a 529 plan and not used for qualified education expenses, they are considered non-qualified withdrawals, which trigger specific financial consequences. The earnings portion of such a withdrawal is subject to federal income tax at the recipient’s ordinary income tax rate. In addition to federal income tax, a 10% federal penalty tax is typically imposed on these earnings.

The principal contributions, which represent the original amounts invested into the 529 plan, are returned tax-free because they were made with after-tax dollars. The Internal Revenue Service (IRS) generally uses a pro-rata rule to determine the portion of the withdrawal attributable to earnings.

There are specific exceptions to the 10% federal penalty tax, though income tax on the earnings may still apply. The penalty is waived if the beneficiary dies or becomes disabled. Another exception applies if the beneficiary receives a tax-free scholarship; in this case, the penalty is waived up to the scholarship amount. The penalty is also waived if the beneficiary attends a U.S. military academy, to the extent that the withdrawal does not exceed the cost of attendance at the academy. Additionally, if the qualified education expenses used to justify the withdrawal are also used to claim certain federal education tax credits, such as the American Opportunity Tax Credit or the Lifetime Learning Tax Credit, the 10% penalty may be waived on the corresponding portion of the earnings.

Alternative Uses for 529 Funds

If a beneficiary does not utilize all the funds in a 529 plan, account owners have several strategic options to avoid the tax implications of non-qualified withdrawals. One common approach is to change the beneficiary of the plan. Funds can be transferred to another eligible family member of the original beneficiary without incurring taxes or penalties.

The IRS defines eligible family members broadly to include:
The beneficiary’s spouse
Children
Stepchildren
Foster children
Adopted children
Siblings
Stepsiblings
Parents
Stepparents
Ancestors
Aunts
Uncles
Nieces
Nephews
First cousins
In-laws of these individuals

Another significant option, introduced by the SECURE 2.0 Act, allows for a limited rollover of unused 529 funds into a Roth IRA for the benefit of the 529 plan beneficiary. This provision enables a lifetime aggregate rollover of up to $35,000 per beneficiary, starting January 1, 2024.

Several conditions apply: the 529 account must have been open for at least 15 years, and contributions or earnings made within the last five years are not eligible for rollover. The rollover amount is also subject to the annual Roth IRA contribution limits for the year, and the beneficiary must have earned income at least equal to the amount rolled over.

Beyond changing beneficiaries or Roth IRA rollovers, account holders can utilize funds for other qualified expenses that may arise. This includes using funds for student loan repayment. Funds can also cover expenses for registered apprenticeship programs. For K-12 students, up to $10,000 per year can be used for tuition, with expanded K-12 qualified expenses becoming eligible in 2025.

Finally, 529 plans have no age limits for using the funds, and the money does not expire. Unused funds can be retained for the beneficiary’s future educational needs, such as graduate school, professional development courses, or even career changes later in life.