What Happens to Money in a 529 If Not Used?

A 529 plan is a tax-advantaged savings vehicle designed to assist individuals in saving for future education costs. These plans offer tax-deferred growth on investments, and withdrawals are tax-free at the federal level when used for qualified education expenses. A common question arises for account holders about funds not fully utilized or leftover after a beneficiary completes their education. Understanding options for managing these funds is important to ensure compliance and avoid financial consequences.

Understanding Non-Qualified Withdrawals

Withdrawing funds from a 529 plan for expenses that do not meet the definition of qualified education expenses constitutes a non-qualified withdrawal. These withdrawals have specific financial repercussions. The earnings portion of a non-qualified withdrawal is subject to federal income tax at the account holder’s or beneficiary’s ordinary income tax rate.

In addition to federal income tax, a 10% federal penalty tax applies to the earnings portion of a non-qualified withdrawal. This penalty is imposed to discourage the use of these tax-advantaged accounts for non-educational purposes. Contributions, made with after-tax dollars, are never taxed or penalized upon withdrawal, regardless of whether they are used for qualified expenses.

Expenses considered non-qualified include a wide range of personal costs not directly related to education. Examples include general living expenses, transportation, health insurance premiums, college application fees, or extracurricular activities not directly required for enrollment or attendance. If funds are withdrawn for such purposes, the account holder or beneficiary is responsible for reporting the taxable earnings and any applicable penalties on their federal income tax return. Understanding these consequences highlights the financial incentive to utilize 529 funds for their intended educational purpose or explore alternative qualified uses.

Alternative Qualified Uses and Transfers

Account holders have several strategies to utilize 529 funds in a qualified manner or transfer them without incurring penalties or full taxation, especially when the initial beneficiary does not fully use the funds. One common approach involves changing the beneficiary of the 529 plan. The account holder can designate a new beneficiary who is an “eligible family member” of the original beneficiary without tax consequences. Eligible family members include siblings, step-siblings, parents, stepparents, children, stepchildren, first cousins, aunts, uncles, nieces, nephews, and the spouse of the original beneficiary. This flexibility allows families to reallocate unused funds to another individual pursuing higher education or other qualified programs.

Beyond traditional higher education, 529 funds can be used for qualified elementary or secondary school tuition. Up to $10,000 per year, per student, can be withdrawn tax-free from a 529 plan for K-12 tuition expenses. As of July 4, 2025, federal law expands this to include additional K-12 expenses such as books, curriculum materials, tutoring, and standardized test fees. Account holders should confirm their state’s specific rules, as some states may treat K-12 withdrawals differently for state tax purposes, potentially requiring recapture of state tax benefits.

Another use for 529 funds is for expenses related to registered apprenticeship programs. The SECURE Act of 2019 expanded qualified expenses to include fees, books, supplies, and equipment, including tools, required for participation in an apprenticeship program certified and registered with the Department of Labor. This provides an avenue for beneficiaries pursuing vocational training to leverage their 529 savings. Information on eligible programs can be found through federal resources like Apprenticeship.gov.

529 funds can be used to repay qualified student loans. The SECURE Act allows for up to $10,000 in lifetime student loan repayment per 529 plan beneficiary. This $10,000 limit applies separately to each of the beneficiary’s siblings. This provision enables families to use leftover 529 savings to reduce student loan debt, providing a valuable financial relief option.

Effective January 1, 2024, the SECURE 2.0 Act allows for the rollover of a limited amount of unused 529 funds into a Roth IRA for the beneficiary. Certain conditions apply: the 529 account must have been open for at least 15 years, and any contributions or earnings rolled over must have been in the account for at least five years. The rollover amount is limited to the annual Roth IRA contribution limits for that year, and there is a lifetime maximum of $35,000 per beneficiary. The beneficiary must also have earned income at least equal to the amount rolled over in that year. This new flexibility offers a pathway to repurpose education savings for retirement without tax penalties.

Impact of Scholarships

Receiving a scholarship, grant, or other tax-free educational assistance can impact how 529 funds are managed, particularly if it leads to excess funds. If a beneficiary receives a tax-free scholarship, the account holder can withdraw an amount from the 529 plan up to the scholarship amount without incurring the 10% federal penalty tax. This exception recognizes that the scholarship has reduced the need for 529 funds for qualified expenses.

While the 10% federal penalty is waived in this specific scenario, the earnings portion of the withdrawn amount is still subject to federal income tax. If a withdrawal is made due to a scholarship, the portion of the withdrawal that represents earnings will be added to the account holder’s or beneficiary’s taxable income. Account holders should keep documentation of the scholarship amount for tax records. This provision offers a way to access funds without penalty if educational costs are covered by other tax-free aid, but tax implications on earnings remain.