How to Handle Unused 529 Funds

Bill Engel in Wealth Management 22 August, 2022

How to Handle Unused 529 FundsTo save for your child’s college education, you may want to choose a 529 plan. Despite how costly college can be, some families still have funds remaining in this plan after their child completes their education. Students may receive an inheritance or gift from relatives, go to a military academy, win a scholarship or choose not to go to college, leaving them with money left in the account. So, what happens with unused 529 funds?

If you have leftover funds in your 529 plan after graduation, you can still use this money, but it’s critical to understand the rules and regulations surrounding how to use 529 plan money. While we believe these plans can be a wise option for college funding, failure to comply with guidelines associated with the plan can lead to penalties. Below, we cover what a 529 fund is and what you can do with unused 529 funds while keeping tax consequences minimal.

What Is a 529 Fund?

A 529 fund is a tax-advantaged savings plan that enables you to save for your or your child’s education expenses. Also known as a qualified tuition plan, this Internal Revenue Code-authorized fund has sponsorship from an educational institution, state agency, or state.

Types of 529 Funds

You can choose either an education savings plan or prepaid tuition plan, which a group of private universities and colleges can also sponsor.

  • Education savings plan: This type of 529 plan lets you open an investment account for future education costs. You can use an education savings plan to cover tuition, fees, books, and room and board. Additionally, you can use the funds for K-12 private school and at nearly any university or college in the U.S.
  • Prepaid tuition plan: This type of 529 plan allows you to purchase college tuition credits to use down the road at today’s prices. As a participant in a 529 plan, you can buy these credits through participating universities and colleges for the plan’s beneficiary. Keep in mind; however, that these credits are not available for secondary or primary schools and will not cover room and board.

If you’re unsure which type of 529 plan is right for you, consult with us at Fort Pitt Capital Group for financial advice.

Tax Benefits of 529 Plans

529 plan earnings grow federal tax-free. There is no tax when you take out money and use it for qualified higher education expenses. Many states also offer state tax deductions, making these plans one of the most efficient ways to pay for a college education.

529 Rules and Regulations

529 Rules and Regulations

Since there are tax advantages to 529 plans, there are also do’s and don’ts to comply with.

  • Enjoy high contribution limits: The IRS doesn’t set contribution limits for 529 funds, but many states do. These high contribution limits allow you to save a significant amount to cover your child’s education.
  • Maintain control of the funds: The funds in a 529 plan remain under your control. You can withdraw your money whenever you want, though penalties and taxes may apply. The beneficiary will not control the account’s funds, regardless of their age.
  • Choose a 529 from any state: Many states offer a 529 plan, though this doesn’t mean you can only use your state’s plan. While some states offer a tax deduction if you do, some do not. If your state doesn’t, you can look around for the right 529 plan for you.
  • Attend a university in any state: Your child doesn’t have to attend college in the state through which you have your 529 plan. Instead, they can attend school in any state, provided they choose an accredited college or university. The exception is if you choose a prepaid plan, which restricts your child to a public in-state school.
  • Adhere to qualified distribution rules: You must use the funds in your 529 on approved expenses, such as tuition, fees, textbooks, computers, room and board, and peripheral equipment, such as a printer. Some plans can also cover tuition for religious or private elementary, middle and high schools. If you withdraw earnings for nonqualified expenses, you will need to pay ordinary income taxes and a penalty, though there are some exceptions.

How to Handle Unused 529 Funds

Though the contribution limits are high, we caution our clients not to overfund the account. Today, there are several alternative options to paying for college, such as loans and grants, and there are penalties when you use 529 plan funds for nonqualified expenses. Careful calculations should go into making projections for the account to prevent overfunding. Talk to a financial advisor to see how to allocate your savings appropriately.

When money is left over in a 529 plan, or if a child decides not to pursue higher education, we don’t recommend removing the money from the account for other purposes. You will incur a hefty penalty. Instead, let the funds grow tax-free. There is no deadline by which you must withdraw the money. You can change the beneficiary once a year, so you can name a sibling or wait until you have grandchildren who might use the funds. You can also consider using the money to further your education.

529 Funds FAQ

Need more information before you make your decision? Below are some of the most frequently asked questions we receive regarding 529 funds.

1. Are 529 Withdrawals Tax-Free?

529 withdrawals are tax-free as long as you’re taking qualified distributions. If you take a nonqualified distribution, the funds will be subject to a penalty and income tax. These costs for nonqualified distributions apply only to the earnings portion.

2. What Happens If You Don’t Use All 529 Money?

If you don’t use all the money in your 529 plan, you can opt to take a nonqualified withdrawal. Remember, you’ll have to pay a penalty plus federal income taxes if you choose to do so. When you remove funds from a 529 plan, a pro-rata distribution is allocated between earnings and contributions. Though the earnings portion is subject to these fees, contributions are penalty-free and tax-free.

3. What Should I Do With a 529 If My Child Does Not Go to College?

If your child chooses not to go to college, another eligible person can use the funds to avoid the penalty and federal income taxes. Your new beneficiary must be a relative of your original beneficiary. Eligible relatives of the original beneficiary include:

  • Spouse
  • Child or stepchild
  • Sibling or stepsibling
  • Parent or stepparent
  • Niece
  • Nephew
  • Aunt
  • Uncle
  • Daughter or son-in-law
  • Mother or father-in-law
  • Sister or brother-in-law
  • Spouses of the above individuals
  • First cousin

4. Can I Transfer Ownership of a 529 Plan to a Beneficiary?

In many states, you can change ownership of a 529; typically, there aren’t any requirements regarding the relationship between the original and new owner. However, many states restrict a transfer of ownership to specific circumstances, such as divorce or the death of the original owner. There are also limits to how often you can change ownership. Changing ownership too frequently could make the transfer a nonqualified distribution.

5. Can I Roll a 529 Plan Into an IRA?

You can’t roll your 529 plan into an IRA because the tax implications between the different accounts don’t match up. A 529 plan is exclusively for education costs, while an IRA is for retirement savings. However, you can withdraw your 529 funds and deposit them into an IRA, though this comes with a penalty and tax implications.

Learn More About Our Financial Advisory Services

529 plans can be an excellent way to save for college, but proper planning to maximize the benefits is essential. At Fort Pitt Capital Group, we can provide you with the financial advisory services you need to determine whether a 529 plan is right for you. We are a team of in-house financial advisors with expertise in financial planning, investment analysis, and wealth management, which means we can provide personalized solutions and results.

If you want a financial advisor you can trust, turn to Fort Pitt Capital Group. We offer exceptional customer service and internal knowledge to benefit you. Contact us to learn more about our financial advisory services.

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