What Happens to Your 529 if Your Child Doesn’t Go to College?

Parents who save in a 529 plan may worry if their child chooses not to pursue higher education. While these accounts are designed for specific educational goals, life circumstances change. Understanding the options for these funds can provide clarity.

Understanding Non-Qualified Withdrawals

Withdrawing funds from a 529 plan for purposes not deemed qualified education expenses carries financial implications. Only the earnings portion of such a non-qualified withdrawal is subject to federal income tax, and potentially state income tax, while the original contributions are returned tax-free because they were made with after-tax dollars.

An additional 10% federal penalty tax applies to the earnings portion of non-qualified withdrawals. For instance, if a 529 account has $20,000 in contributions and $10,000 in earnings, and a non-qualified withdrawal of $15,000 is made, one-third ($5,000) of that withdrawal would be considered earnings subject to both income tax and the 10% penalty. The remaining $10,000 would be the tax-free return of principal.

There are specific exceptions where the 10% federal penalty may be waived, even if the withdrawal is not for qualified educational expenses. These include instances where the beneficiary dies or becomes disabled, preventing them from using the funds as intended. The penalty is also waived if the beneficiary receives a tax-free scholarship, but the earnings portion remains subject to income tax.

Other circumstances that may exempt a withdrawal from the 10% penalty include the beneficiary attending a U.S. military academy or receiving educational assistance through a qualifying employer program. Additionally, if the qualified education expenses were used to generate the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC), the penalty may be waived.

Expanding Qualified Education Expenses

The definition of “qualified education expenses” for 529 plans extends beyond four-year college tuition. These expenses apply to eligible post-secondary institutions, which include colleges, universities, vocational schools, trade schools, and certain apprenticeship programs registered with the U.S. Department of Labor.

Qualified expenses encompass tuition, mandatory fees, books, supplies, and equipment required for enrollment or attendance. The cost of computers, related peripheral equipment, software, and internet access also qualifies, provided they are used primarily by the beneficiary during their enrollment at an eligible educational institution.

Room and board expenses are also considered qualified, but specific rules apply. For these costs to qualify, the student must be enrolled at least half-time at an eligible educational institution. The qualified amount for room and board cannot exceed the allowance for room and board as determined by the educational institution for federal financial aid purposes, or the actual amount charged if the student lives in institution-owned housing.

For students with special needs, certain expenses incurred in connection with their enrollment or attendance at an eligible educational institution are qualified. This includes specialized equipment or services necessary for their participation in coursework. Additionally, up to $10,000 annually per beneficiary can be used for K-12 tuition expenses at public, private, or religious elementary or secondary schools. Starting July 4, 2025, the definition of qualified K-12 expenses expanded to include books, curricular materials, tutoring, and testing fees, with the annual limit increasing to $20,000 per student in 2026.

Options for Beneficiary Changes and Rollovers

If a child does not attend college, or if funds remain after their education, several strategies can repurpose 529 funds without penalties. One option involves changing the beneficiary of the account to an eligible family member of the original beneficiary without tax consequences.

An “eligible family member” is broadly defined by the IRS and includes siblings, step-siblings, children, stepchildren, foster children, adopted children, and their descendants. Parents, stepparents, aunts, uncles, nieces, nephews, and first cousins, along with their spouses, are also considered eligible. The process for changing a beneficiary involves completing a form through the 529 plan’s website.

A recent provision, introduced through the SECURE Act 2.0, allows a limited amount of 529 funds to be rolled over to a Roth IRA for the benefit of the original beneficiary. This option became available as of January 1, 2024. The 529 account must have been open for at least 15 years to qualify for this rollover.

There is a lifetime rollover limit of $35,000 per beneficiary for transfers from a 529 plan to a Roth IRA, and annual rollovers are subject to the Roth IRA contribution limits for that year. For 2025, this limit is $7,000, or $8,000 if the beneficiary is age 50 or older. Funds contributed to the 529 plan within the last five years, along with their associated earnings, are not eligible for this Roth IRA rollover. The beneficiary must also have earned income at least equal to the amount rolled over in that year.

Another alternative use for 529 funds is the repayment of qualified student loans. Up to $10,000 per beneficiary, with a lifetime limit, can be used to pay down qualified student loans for the beneficiary or their siblings. This provision, established by the SECURE Act of 2019, allows for tax-free and penalty-free student loan repayment. The $10,000 limit applies per individual, meaning a family with multiple children could use more in aggregate across their beneficiaries.