Are you facing the fortune of having saved too much for college through your 529 college savings plan? Perhaps your son or daughter received a scholarship or did not attend school. If so, there are several options as to what to do with the funds without facing income taxes or penalties.
If you pull the excess funds out of the 529 plan and don’t use it for qualified expenses, the earnings portion of the withdrawal is taxable and you will also get hit with a 10% penalty. For example, let’s say you have $10,000 leftover and that represents $8,000 of original contributions and $2,000 of earnings. The $2,000 will get added to your taxable income and be taxed at your marginal tax rate, and you will also have a $200 penalty.
However, there are options on handling the excess 529 plan funds that save on these taxes.
1. Keep the plan and save it for future educational expenses for the same beneficiary
There is no penalty for leaving the plan alone for the time being. Maybe there is a possibility of your child going back to school, earning an advanced degree, or taking classes at any eligible post-secondary institution, including vocational and technical schools. Eligible expenses include tuition, fees, books and supplies for the classes, and reasonable room and board. Up to $10,000 in tuition for an elementary, secondary public, private or religious school is also included in the “qualified list.
Eligible schools include colleges, universities, vocational schools, or other post secondary schools eligible to participate in a student aid program of the Department of Education. This includes nearly all accredited public, nonprofit, and proprietary (for-profit) post secondary institutions. A school should be able to tell you whether it qualifies.
2. Transfer the 529 to another beneficiary
As the account owner, you can change the beneficiary to another qualifying family member (spouse, child, parent, grandchildren, in-laws, etc) without any tax consequences. This is a perfect solution if you have younger children who need additional funds, or even grandchildren if you want to start a plan for them.
3. Pay off student loans
Under the new SECURE Act passed in 2019, the new law allows you to withdraw up to $10,000 from 529 college savings plans to make student loan payments for the beneficiary or a sibling of the designated beneficiary.
With proper planning and knowledge of these laws, it is very easy to avoid taxes and penalties on distributions.