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Your 529 Has Money Left Over?

So, you (or one of your kids) recently graduated from college! Perhaps you are among the 16 million families in the U.S. who helped fund college tuition using a 529 college savings plan. And depending on the type of higher education you or your student pursued, you may have leftover 529 funds. Today, we explore some options for those extra dollars and the potential tax implications.

Keep it in the family.

While the 529 savings account was originally intended for you, you’re not the only person who can benefit from those funds. While you as the original beneficiary could use the extra funds for further education, the account owner can generally change the beneficiary of a 529 account to a “family member” without incurring tax or penalties, giving you some flexibility on who can use the extra funds. Generally, you can change the beneficiary to any relative at the same generation or one generation above or below the original beneficiary (including spouses) – first cousins are as far as you can go. Someone planning to have a child one day could use the money for that child in the future, increasing the amount of time the funds can remain invested.

Rollover up to $35,000 to a Roth IRA.

The SECURE 2.0 Act passed in 2022 created a new option for unused 529 funds: the ability to roll over up to $35,000 to a Roth IRA (an “individual retirement account” that offers tax-free growth) for the beneficiary during their lifetime. However, there are several rules around this option. For example, each year, the rollover amount is limited to the maximum Roth IRA contribution for that year ($7,000 in 2024). Furthermore, some rules still need some clarity from the IRS — like the one requiring the 529 account to have been maintained for at least 15 years before rolling funds over. While we aren’t yet certain of how this option will work in practice, it provides an excellent tax-advantaged option for unused 529 funds not restricted to education expenses.

Withdraw and pay the tax and penalty.

At EVOadvisers, we like to say, “don’t let the tax tail wag the dog” – essentially, sometimes the best option for your situation is not the most optimal on your income tax return. Though it’s the least tax-efficient option, simply withdrawing funds from a 529 account for a non-qualified expense (like funding a home purchase downpayment) and paying the income tax and penalty can be the right option as well. In Virginia, the tax works like this: you’ll pay Federal and state income tax plus a 10% penalty on just the growth (“earnings” minus what was contributed) attributable to the withdrawal. Virginia does not currently claw back any of the state tax deduction you may have received when contributions were made.

If you or someone you know has questions about their options for unused 529 funds, the team at EVOadvisers would be happy to assist!

Sources:

https://www.schwab.com/learn/story/saving-college-529-college-savings-plans#:~:text=If%20you%20simply%20withdraw%20the,(not%20on%20your%20contribution).