What If You Don’t Use Your 529 Plan?

A 529 college savings plan is a state-sponsored investment vehicle designed to help individuals save for education expenses. Its primary purpose is to allow money to grow tax-free and be withdrawn tax-free for qualified education costs. These plans offer a tax-advantaged way to finance educational pursuits, ranging from K-12 tuition to graduate school. A common concern for account holders involves scenarios where the anticipated educational path changes, leading to questions about how to manage these funds if they are not used as originally intended.

Consequences of Non-Qualified Withdrawals

A withdrawal from a 529 plan is considered “non-qualified” if it is not used for eligible education expenses as defined by the IRS. When a non-qualified withdrawal occurs, the earnings portion of the distribution becomes subject to federal income tax at the recipient’s ordinary income tax rate.

In addition to federal income tax on the earnings, a 10% federal penalty tax is applied to that same earnings portion. The principal amount contributed to the 529 plan is not taxed or penalized upon withdrawal, as these contributions were made with after-tax dollars. State income taxes and penalties may also apply, depending on the specific state’s rules, potentially recapturing previous state tax benefits.

Common situations leading to non-qualified withdrawals include using funds for non-education expenses or withdrawing more money than the total qualified education expenses incurred for the year. If a distribution is taken in a different tax year than the expenses were incurred, it could also be deemed non-qualified. The individual who receives the non-qualified payment, whether the account owner or the beneficiary, is responsible for reporting and paying taxes on the earnings.

Strategies for Penalty-Free Use

Account holders have several methods to utilize 529 funds without incurring penalties, even if the initial educational plans shift. One flexible option is changing the beneficiary to another eligible family member of the original beneficiary. The IRS broadly defines eligible family members to include:
Spouses
Children (including step, foster, and adopted)
Siblings
Parents
In-laws
Aunts
Uncles
First cousins
This change can be made without tax consequences or penalties.

Qualified Higher Education Expenses (QHEE) include more than just tuition, offering many penalty-free uses for 529 funds. These expenses include:
Fees
Books
Supplies
Equipment required for enrollment or attendance
If the student is enrolled at least half-time, room and board costs also qualify, including on-campus housing or an allowance for off-campus housing.

For elementary and secondary education, up to $10,000 annually per beneficiary can be used for K-12 tuition expenses. This provision applies to public, private, or religious schools. Additionally, 529 funds can cover expenses related to registered apprenticeship programs, provided they are approved by the US Department of Labor.

Another avenue for penalty-free use is student loan repayment. Account holders can use 529 funds to pay up to a $10,000 lifetime limit per individual for qualified student loan principal and interest payments. This applies to the beneficiary’s loans or those of their siblings.

A recent provision allows for limited rollovers from 529 plans to Roth IRAs. To qualify for a 529-to-Roth IRA rollover, the 529 plan must have been open for at least 15 years, and contributions made within the last five years are not eligible for rollover. The aggregate lifetime limit for such rollovers is $35,000 per beneficiary, and the annual rollover amount cannot exceed the annual Roth IRA contribution limit, which is $7,000 for 2025. The beneficiary of the 529 plan must also be the owner of the Roth IRA and have earned income at least equal to the rollover amount.

Managing Remaining Funds

Remaining funds may exist after a beneficiary completes education or if scholarships reduce the need for plan funds. One straightforward option is to leave the funds within the plan for future educational needs. There is no age limit for using 529 funds, nor is there a “use-it-or-lose-it” expiration date. This allows for potential graduate school, professional development, or even a career change later in life.

If a beneficiary receives a scholarship, a specific exception applies to the 10% federal penalty tax. An amount equal to the scholarship can be withdrawn from the 529 plan without incurring this penalty. However, the earnings portion of that withdrawal will still be subject to federal income tax, as it is not being used for a qualified education expense.

Changing the beneficiary to another eligible family member is a viable strategy for managing surplus funds. This allows the account to continue tax-advantaged growth for another individual’s education, such as a younger sibling or even the account owner themselves. This transfer does not trigger tax consequences. Remaining funds can also be directed towards other qualified expenses, such as student loan repayment or K-12 tuition. For example, the $10,000 lifetime limit for student loan repayment can help absorb excess funds and exhaust the 529 balance without penalties.