Using a 529 plan to save up money for college expenses is a smart move, as it allows you to benefit from tax-deferred growth and use the funds tax-free if they’re directed toward eligible expenses. But once you’ve finished paying for college, you may have questions about what you can do with the unused 529 funds. Fortunately, there are several options. Here’s a look at where you can direct the unused 529 funds and the implications of each choice.
Transfer the Funds to a New Beneficiary
If you had a 529 plan for an eligible family member and they didn’t use all of the money, but you have a second eligible family member who has yet to complete college, you can transfer the unused 529 funds to the second person. The rollover can be tax-free as long as the new beneficiary is a qualifying family member of the original beneficiary, such as a parent, child, sibling, niece, nephew, or first cousin.
This option works well for multi-child households, as there’s a clear potential secondary beneficiary. However, there are other strategies to consider. For example, if the original beneficiary may want to have a child of their own one day, they could maintain the 529 in their name and transition it to their child once it’s born. That’s an option even if they don’t have a child for years after they graduate.
Roll the Money into a Roth IRA
One of the newer options for unused 529 funds is to roll the leftover money into a Roth IRA. This option becomes available in 2024, is tax-free, and works on up to $35,000 in remaining 529 funds. There are additional rules to consider. For example, contributions made within the last five years aren’t eligible. Additionally, the 529 account must be a minimum of 15 years old, and the beneficiary must have earned income in the year the transaction occurs.
Another critical point is that the Roth IRA must belong to the 529 plan beneficiary. Now, it is possible to change the beneficiary before rolling the funds over into a Roth IRA. As long as the new beneficiary is a direct family member (no more than one generation apart), there are no tax implications surrounding the transfer. Then, the new beneficiary could use the money to fund or increase the value of a Roth IRA in their name.
Just keep in mind that completing the rollover may take several years. While you can transfer up to $35,000 in total, the Roth IRA annual contribution limits still apply. As a result, you can only roll over $6,500 to $7,500 per year (based on current contribution limits). Since that’s the case, you may need to roll over portions of the remaining 529 plan balance for multiple years to empty out the account.
Additionally, it’s critical to note that 529 plan rules can vary. While Congress approved these rollovers, states may not allow the activity. This option is relatively new, so not all states may have adjusted their 529 plan rules to accommodate the upcoming change yet. As a result, it’s critical to check the limitations of the 529 plan in question before attempting a rollover into a Roth IRA.
Pay Eligible Student Loans
Another option for unused 529 funds is to pay up to $10,000 on qualifying student loans. The money can be used for student loans held by the beneficiary, as well as their siblings. The $10,000 is a lifetime limit, but it’s a way to use the funds tax-free to eliminate some or all of an often-cumbersome debt.
Move the Money to an ABLE Account
If the beneficiary of the 529 plan becomes disabled, you can roll the unused 529 funds into an ABLE Account. ABLE Accounts are tax-advantaged savings account options that benefit disabled individuals, and earnings in the account aren’t subject to taxes. As a result, this is a solid choice for qualifying individuals. Just bear in mind that contribution limits will apply, so it may take time to roll over the funds from the 529 plan.
Withdraw the Money
Finally, withdrawing the money is always an option, but it can come with a financial downside in some situations. Along with owing taxes on the withdrawn amount, there’s typically a 10 percent penalty to contend with, too. Still, that may seem manageable if there’s no other clear use for the money.
However, if the beneficiary received scholarships, withdrawing an amount equal to the scholarship can be done without paying taxes or penalties. The same is true if the beneficiary attended a military academy, where they can withdraw the cost of their advanced education without facing a tax burden or owing a penalty fee.
Additionally, if the beneficiary becomes disabled before the withdrawals are made, the 10 percent fee is waived. That’s also true if the beneficiary passes away before there are any withdrawals. Still, income taxes will apply to the earnings in these situations.
Wait to Decide
If you aren’t sure what’s best to do with the unused 529 funds, you don’t have to decide right away. The money can remain in the account indefinitely, and it will continue to grow as it sits.
Waiting can be worthwhile if there’s no immediate need for the funds and the current choices don’t provide a clear benefit. For example, if the beneficiary is already fully funding a Roth IRA without issue, there isn’t a qualifying individual to transfer the funds to, there aren’t any student loans to address, the beneficiary isn’t disabled, and the idea of paying the penalty on withdrawals now is unappealing, waiting to decide is an option. The beneficiary can always choose how they want to use the money at a later date, as there’s no deadline for making such a decision.
Do you know of anything else people can easily do with unused 529 funds that they may want to consider? Did you take advantage of unused 529 funds and want to tell others how you leveraged them? Share your thoughts in the comments below.
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Tamila McDonald has worked as a Financial Advisor for the military for past 13 years. She has taught Personal Financial classes on every subject from credit, to life insurance, as well as all other aspects of financial management. Mrs. McDonald is a former AFCPE Accredited Financial Counselor and has helped her clients to meet their short-term and long-term financial goals.