This may not occur often but there are some cases in which a family may unexpectedly have unused money in their college student’s 529 account. How can this happen? Your child may end up being an unbelievable athlete or scholar and receive unplanned scholarship. Picking a state school versus a private institution may also require less college funds. Then there is also the case where your child could leave college early either by dropping out or graduating early. With any of these scenarios, a family may find they have some leftover unused 529 money.
Where should these funds go now? The answer to this question will vary depending on the family and the beneficiary of the 529 account. If the current beneficiary of the account plans to attend graduate school, the funds can be used for this. If your child has dropped out of school but plans to go back to college later the parents can leave the money in the account where interest will continue to grow. When your child eventually goes back to college, the money could be used at that time.
Another option for the family is to transfer the funds to another beneficiary. This beneficiary can be another sibling in the family or a cousin. It could also be transferred to a parent as the beneficiaries and used for their own continuing education. If the parent is the owner of the plan, they control who is designated as the beneficiary. You can delay the decision and save the funds for a current or future grandchild.
If a family decides to take the money and use it for non-qualified expenses then it is important to understand that the family will have to pay a 10% penalty plus income tax on any gains on the 529. I would not suggest this option but in certain situations, a family may need the money.
I mentioned earlier that your child might receive a scholarship, which you were not counting on. In this situation, a family may receive a penalty-free scholarship withdrawal. Check with your accountant. The scholarship needs to fall under Section 117 of the IRS code or under the educational benefits under the GI bill. The amount of the withdrawal needs to be the same amount as the scholarship. The family will avoid the 10% penalty but will still need to pay any tax gains from the investment.
There are also more involved tax strategies if the 529 investments have lost money. Please seek advice from your accountant in this case. Each state has different tax consequences concerning changes in 529 plans and you should seek proper advice before making any changes.
Saving for college is difficult but a 529 plan is a great tax-advantaged college investment account. It is just one tool of many that can be used to lower your cost of educating your child. Good luck with your college planning and saving.