What Happens to Unused College Fund Money?

A college savings plan, most commonly a 529 plan, offers a tax-advantaged way to save for future educational expenses. These plans allow contributions to grow tax-free, and withdrawals are also tax-free when used for qualified education costs. Families often wonder what happens to the money if the designated beneficiary does not use all the funds.

Understanding Qualified Educational Expenses

Understanding what constitutes a “qualified higher education expense” is important when utilizing college savings plans. These expenses are defined by the Internal Revenue Service (IRS) and include a broad range of costs associated with eligible educational institutions. Qualified expenses generally encompass tuition and fees required for enrollment or attendance at colleges, universities, and vocational schools.

Funds can cover books, supplies, and equipment necessary for coursework. The purchase of computer technology, equipment, software, and internet access primarily used by the student also qualifies. Room and board expenses are included for students enrolled at least half-time, though these costs cannot exceed the allowance determined by the educational institution for financial aid purposes, or the actual amount charged for on-campus housing.

Account owners can use up to $10,000 annually per beneficiary for tuition at elementary or secondary public, private, or religious schools. From July 4, 2025, this K-12 allowance broadens to include other educational expenses such as curricular materials, books, tutoring, and standardized test fees, with the annual limit increasing to $20,000 in 2026. Additionally, 529 funds can be applied to fees, books, supplies, and equipment required for participation in registered apprenticeship programs. A lifetime limit of $10,000 per individual applies to using funds for principal and interest payments on qualified student loans for the beneficiary or their siblings.

Reallocating Unused Funds Tax-Free

Several strategies allow account owners to reallocate unused college funds without incurring taxes or penalties. These strategies provide flexibility for managing college savings. One common approach involves changing the beneficiary of the 529 plan. This can be done without tax consequences as long as the new beneficiary is an eligible family member of the original beneficiary.

The IRS defines eligible family members broadly, including:

• The original beneficiary’s spouse, children, stepchildren, adopted children, and their descendants.
• Siblings, parents, stepparents, and ancestors of either.
• Aunts, uncles, nieces, nephews, and first cousins, along with their spouses.

This flexibility allows families to shift funds to another child, a grandchild, or even the account owner themselves if they plan to pursue further education.

Funds can also be rolled over from one 529 plan to another. This may be done for the same beneficiary once every 12 months, or at any time if the new plan benefits a different eligible family member. For the rollover to remain tax-free, the funds must be transferred to the new 529 plan within 60 calendar days of the withdrawal from the original account. This option provides flexibility to explore different state plans or investment choices.

Withdrawing Funds for Non-Qualified Uses

When college savings are withdrawn for purposes not considered qualified educational expenses, specific financial consequences arise. The earnings portion of such non-qualified withdrawals becomes subject to ordinary federal income tax. Depending on the state of residence, state income tax may also apply to these earnings.

The tax liability for non-qualified withdrawals generally falls on the individual who receives the payment, whether it is the account owner or the designated beneficiary. The portion of the withdrawal that represents the original contributions, or basis, is not taxed because these amounts were contributed with after-tax dollars. The calculation of the earnings portion is typically proportional to the ratio of earnings to contributions in the account.

In addition to income tax, a 10% federal penalty tax usually applies to the earnings portion of non-qualified withdrawals. This penalty is designed to encourage the use of 529 plans for their intended educational purpose. Certain exceptions to this 10% penalty exist, however, providing relief under specific circumstances.

The 10% penalty is waived if:

• The withdrawal is due to the death or disability of the beneficiary.
• Similarly, if the beneficiary receives a scholarship, the penalty is not imposed on withdrawals up to the amount of the scholarship.
• Attendance at a U.S. military academy also exempts withdrawals from the penalty, up to the cost of advanced education.
• Furthermore, if the qualified education expenses are reduced because of the beneficiary electing to claim the American Opportunity Tax Credit or Lifetime Learning Tax Credit, the penalty may be avoided.