What Happens to 529 Plan Funds if Not Used for College?

September 1, 2021
  • facebook
  • linkedin
  • twitter
  • google plus

Many families invest in 529 plans for college savings. They are a great way to put money aside and gain tax-free investment earnings until the funds are ready to be used for expenses like tuition, books/supplies, room and board. But, what happens when your kid(s) decide not to go to college? What becomes of your 529 plan funds?

This is a common scenario and it is definitely one of the major limitations of investing in 529 college savings plans. Your child (or multiple children) that you have been saving up for decides he or she doesn’t want to go to a four-year university. Or, maybe they go for one or two years and drop out. You are left with extra money in the plan that is supposed to be used only for college expenses.

The good news is you aren’t going to lose all this money. You have options, which we will outline here.

Option #1: Use it for Different Qualifying Educational Expenses

People think of 529 plans as only for “college savings,” but they can actually be used for a number of different educational expenses. The Tax Cuts and Jobs Act of 2017 (TCJA) expanded qualifying educational expenses to include K-12 tuition (up to $10,000 per year per student). 529 plans can also be used to fund some eligible postsecondary institutions like community colleges, trade schools and certificate programs. You’ll want to research which options are available to you and which may apply to your children’s job education/training.

Option #2: Transfer the 529 Plan to the Beneficiary

You always have the option to transfer the 529 plan itself to the beneficiary (i.e., your child once they are of age). This allows them to use it for a later date or make their own early withdrawals (which will of course be subject to penalties and taxes). If there is a chance that your child eventually goes to college, it is best to hold onto the 529 plan under your name to maintain better long-term tax benefits. Once it is transferred, it becomes a taxable asset for them and could increase the EFC (Expected Family Contribution).

Option #3: Transfer the 529 Plan to a Different Beneficiary

Another option you can take advantage of is to transfer the plan to a different family member. Any relative is eligible to receive the plan without penalty. We’re talking parents, grandparents, aunts, uncles, nieces, nephews, in-laws, cousins, etc. Even non-relatives can be eligible if they have lived with you for a majority of the current tax year.

Option #4: Accept the 10% Penalty

You will be subject to a 10% penalty if withdrawing any 529 plan funds to be used for anything other than qualified educational expenses. This can be a tough pill to swallow, but you aren’t losing all your money. Ideally, your plan has made you much more than 10% over the years, so it’s probably not a net loss. If you have no other options, you can take your money out, accept the penalty and move on.

This option is a perfect reminder that there may be other ways to save for your children’s college savings that won’t lock you into a 529 plan. These plans do offer great benefits if you know for sure your children are going to college. If there are any uncertainties, you might want to look into alternative investment and savings plans that will offer more flexibility and better benefit you and your children in the future.

Option #5: Special Circumstances

There are some extenuating circumstances where you can transfer or withdraw your 529 plan funds without the 10% penalty. For example, children born with disabilities or special needs can allow you to convert a 529 plan into an ABLE (Achieving a Better Life Experience) account to help pay for additional qualifying expenses. Other extenuating circumstances include:

  • Military Academy—Funds can be used for military school with no penalty.
  • Scholarships—Funds can be withdrawn matching any scholarship amount with no penalty.
  • Death—If the beneficiary dies, the funds can be withdrawn with no penalty.
  • Disability—If the beneficiary is diagnosed with a disability, the funds can be withdrawn to pay for certain disability expenses (or you can transfer to an ABLE account).

These are some of the alternatives you should consider if you already have a 529 plan and your kids decide not to go to college—or if some other unforeseen circumstance occurs. It’s important to understand you to have options. You also have options for different ways of saving for college expenses that may not include a 529 plan. Every family is different and you’ll want to create a financial plan that will give you and your kids the brightest future possible.

Talk with the financial planning experts at Illumination Wealth. Contact us today to set up a no-obligation introductory consultation. Let us help you save for college and retirement while building a successful path to financial independence!