Despite the burgeoning cost of higher education these days, you might still find yourself with unspent money in a 529 plan after your child has graduated from college. As you may know, if you withdraw the money for nonqualified education purposes, you have to pay taxes plus an additional 10% penalty on the earnings withdrawn from the account.
Are there ways to use the money while avoiding the taxes and/or penalties? Quite a few, as it turns out. Following are some options to consider.
• Use it for graduate school. If your child is interested in furthering his or her education, the money can be used tax free, just as it was for college. Any higher-education institution that receives financial aid qualifies.
• Use it for another child. You are allowed to change the beneficiary of the 529 plan to another qualifying family member without any tax consequences. If you have other children soon to enter or currently in college, the money can be used to pay for their qualified expenses even if you have other 529 plans set up for them. Furthermore, since 2018, money in 529 plans can be used for elementary and secondary education as well. It’s a great option if you have younger children in private schools.
• Use it for another relative. The IRS allows you to change the beneficiary not only to his or her siblings, but also to parents, aunts, uncles, nieces, nephews, stepparents and even first cousins. There is no time limit for using the funds, so you even can save it as a potential gift for a future grandchild. One caveat: Try to avoid skipping a generation (for example, changing the beneficiary to the current beneficiary’s grandchildren). Such a move could trigger a tax penalty.
• Use it for your own or your spouse’s career. As mentioned above, either of you qualifies as a successor beneficiary, and the list of qualified schools includes community colleges, art and music schools, and vocational and trade schools. Even certificate programs and continuing-education courses may qualify. Whether you are interested in changing your career or simply want to enjoy earning a new degree in retirement, using leftover 529 funds enables you to avoid dipping into your other savings.
• Use it as an estate-planning vehicle. You can choose to bequeath a 529 account to an heir. You retain control of the account until you die, and can continue to make annual tax-free contributions up to the gift-tax exclusion amount (currently $15,000) as long as the account value does not exceed the state-mandated maximum limit ($475,000 in California). Plus, after you pass away, the value is not counted as part of your estate for estate transfer tax purposes.
• Use it to offset any scholarships your child received while in college. You can withdraw any amount from the 529 plan up to the value of all scholarships and have the 10% penalty waived even if you apply years after the scholarship was earned. The earnings will still be taxable, but because distributions include both earnings and contributions, only a portion will actually be taxed.
• Use it for a disabled beneficiary or for one who enlists in the military. As above, you’ll still need to pay taxes on the earnings but will avoid the 10% penalty.
• Give the money to your child or spend it yourself. In other words, bite the bullet and pay the taxes and the 10% penalty. The earnings will be taxed at your child’s rate, which could be low if he or she is just starting out in the workforce. In the rare case that the value of the 529 account is currently less than the total amount you originally contributed due to poor investment performance, you might even be able to claim the loss on your tax return.
For more information, consult IRS Publication 970.