What If I Don’t Use All My 529 Money?

A 529 plan serves as a tax-advantaged savings vehicle specifically designed to help families cover education expenses. These plans offer tax-deferred growth on investments, and withdrawals are tax-free when used for qualified educational purposes. A common concern arises when the intended beneficiary completes their education, receives scholarships, or chooses a less expensive path, leaving residual funds in the account. Understanding the various options for these unused funds is important for account holders to avoid potential tax implications and penalties.

Defining Qualified Education Expenses

For withdrawals from a 529 plan to be tax-free, they must be used for qualified education expenses at an eligible educational institution. These institutions include virtually all accredited public and private colleges, universities, vocational schools, and other post-secondary educational institutions that participate in a student aid program administered by the Department of Education.

Tuition and fees are primary qualified expenses, covering the cost of enrollment at an eligible institution. This also extends to books, supplies, and equipment required for courses. Additionally, expenses for special needs services incurred by a special needs beneficiary are considered qualified.

Room and board can also be qualified expenses for students enrolled at least half-time. The amount that qualifies for room and board is limited to the allowance determined by the educational institution for federal financial aid purposes, or the actual amount charged if the student lives in institution-owned housing.

Recent legislative changes have expanded the scope of qualified education expenses beyond traditional higher education. Account owners can now use up to $10,000 annually per beneficiary for tuition expenses in connection with enrollment or attendance at an elementary or secondary public, private, or religious school. This annual limit applies on a per-beneficiary basis, meaning multiple 529 accounts for the same beneficiary are aggregated for this limit.

Another significant expansion includes payments for student loans and registered apprenticeship programs. Up to $10,000 in student loan repayments per beneficiary is considered a qualified expense over the beneficiary’s lifetime. This $10,000 lifetime limit also applies to student loans for siblings of the beneficiary. Qualified expenses also include costs for registered apprenticeship programs, provided they are certified by the Secretary of Labor.

Options for Reassigning 529 Funds

When a beneficiary does not exhaust all 529 funds, account owners have several strategies to reassign the money without incurring taxes or penalties. One common approach involves changing the designated beneficiary to another eligible family member. This allows the funds to maintain their tax-advantaged status for educational purposes within the family.

Eligible family members, as defined by the Internal Revenue Service, include the beneficiary’s spouse, child, stepchild, foster child, adopted child, or their descendants. Siblings, stepsiblings, parents, ancestors, nieces, nephews, aunts, uncles, and first cousins of the original beneficiary, as well as the spouse of any of these individuals, also qualify.

Transferring funds to another 529 plan for the same or a new beneficiary is another permissible action. This can be done without tax consequences, provided the new beneficiary is an eligible family member. This helps manage funds if educational plans change or if a beneficiary receives scholarships.

Rolling Over Funds to a Roth IRA

A new provision allows for the rollover of unused 529 plan funds into a Roth IRA, offering an additional avenue for managing surplus education savings. This option became available starting in 2024, providing a tax-free and penalty-free transfer under specific conditions.

Strict conditions govern this type of rollover. The 529 account must have been open for at least 15 years. The rollover must be for the benefit of the 529 plan’s designated beneficiary, and the Roth IRA must be in that same beneficiary’s name.

There is a lifetime limit on the amount that can be rolled over from a 529 plan to a Roth IRA, currently set at $35,000 per beneficiary. This limit is cumulative across all 529 plans held by the beneficiary. Additionally, any contributions made to the 529 plan within the last five years, along with their associated earnings, are not eligible for this type of rollover.

The amount rolled over from the 529 plan into the Roth IRA is also subject to the annual Roth IRA contribution limits applicable to the beneficiary. The rollover amount combined with any other Roth IRA contributions by the beneficiary cannot exceed this annual limit.

Understanding Non-Qualified Withdrawals

If funds from a 529 plan are withdrawn for purposes other than qualified education expenses or eligible rollovers, these are considered non-qualified withdrawals. Such withdrawals have specific tax implications, primarily affecting the earnings portion of the distribution. The principal contributions, which were made with after-tax dollars, are returned tax-free.

The earnings portion of a non-qualified withdrawal is subject to ordinary income tax. In addition to income tax, a 10% federal penalty tax typically applies to the earnings portion of the non-qualified withdrawal.

There are specific exceptions to the 10% federal penalty tax, though the earnings may still be subject to ordinary income tax. These exceptions include withdrawals made due to the death or disability of the beneficiary. If the beneficiary receives a tax-free scholarship, fellowship, or other educational assistance that reduces their need for 529 funds, an amount up to the scholarship amount can be withdrawn without incurring the 10% penalty. However, the earnings on this portion are still subject to income tax.

Other penalty exceptions may apply if the beneficiary attends a U.S. military academy or receives veteran’s educational assistance. Even with these exceptions, only the penalty is waived, not the income tax on the earnings.