A 529 plan is a tax-advantaged investment account for education savings, offering tax-free growth and withdrawals when used for qualified education expenses. If a college education for your offspring is on your radar, the best practice is to open a 529 when your baby is born. However, as the bard said, “Tis many a slip twix cup and lip.” Another way to put it is, “A lot of stuff can happen in eighteen years.” For example, when your kid hits middle school, you might discover he isn’t “college material.”
1. Use the money for other types of post-secondary education.
Many people think of a 529 plan as just a four-year college funding vehicle, but it’s actually far more versatile. Your kid isn’t going to get very far with a high school diploma these days. I am a HUGE proponent of attending community college or technical college to obtain marketable skills, e.g. many types of associates of applied science degrees or associate of occupational studies degrees lead to “breadwinner” jobs. Many more high school graduates should be looking to gain marketable skills in community colleges, CTE, apprenticeship programs, trade schools, or vocational schools,
2. Help pay off student loans.
You may have other children who took out student loans, or you might still be paying off some of your own, and you can now use 529 plan proceeds to help pay these off. A $10,000 maximum lifetime limit applies for a beneficiary and each sibling. For example, your 529 beneficiary didn’t go to college, but they have two older siblings with student loans. Up to $10,000 per sibling can be withdrawn without federal taxes or penalties to pay down these debts, provided you make the loan payment in the same year you withdraw the funds. Alternatively, if you change the beneficiary to yourself, you may be able to use your child’s 529 plan to help pay off some of your own student loans.
3. Roll over the funds to a Roth IRA for the beneficiary.
The new SECURE 2.0 law provides some increased flexibility for unused 529 assets. Account owners of a 529 plan are now allowed to roll over unused 529 assets to a Roth IRA for the beneficiary, subject to certain criteria and limits.
There are specific requirements in order to use this new qualified 529 distribution. First, a 529 account must be open for the beneficiary for 15 years. Second, the Roth IRA must be for the same beneficiary of the 529. Third, your contributions—also known as the principal—must have been in your 529 account for at least five years before the Roth IRA rollover. There are additional rules. You would be wise to check with your financial advisor or tax consultant to evaluate your options.
4. Change beneficiaries.
Is there someone else who could benefit from the 529 plan? The process to switch beneficiaries is quite simple. Alternatively, you can roll it over to another 529 plan, which can be done once every 12 months per beneficiary. There shouldn’t be any federal taxes or penalties as long as the new beneficiary is a qualified family member of the current beneficiary. So, if your child opts out of college, you can name a younger sibling or even a niece or nephew or potentially another relative. And you can even name yourself or your spouse as the beneficiary if you’re interested in furthering your education.
5. Leave the account intact.
You can leave the 529 plan in place for future generations, e.g. unborn grandchildren, since contributions to a 529 plan are generally considered completed gifts for tax purposes and are removed from your estate.
Your financial advisor can help you determine how a 529 plan can fit into your overall financial strategy. It’s a valuable tool for helping your family members explore the educational opportunities that can lead to a promising future.
6. Pay for qualified K-12 expenses.
I’m not a big fan of using a 529 plan to pay for K-12 expenses, because one of the beauties of the 529 plan is seeing your savings grow for eighteen years until your offspring reaches college age. However, the rules allow it. If you’ve got younger kids in private school, you may be able to use 529 plans to pay up to $10,000 per student, per year, for qualified K-12 expenses, which typically includes tuition and necessary fees. As is the case with 529 plans used for college, your earnings and withdrawals are free of federal taxes if the money is used for qualified expenses.
7. You may qualify to exercise a loophole.
The 529 plan has a loophole. As I have noted, a withdrawal from a 529 plan that doesn’t cover eligible college costs is subject to a 10% penalty from the IRS. A few notable exceptions to the 10% penalty rule include when the beneficiary becomes incapacitated, attends a U.S. Military Academy, or gets a scholarship. In the case of a scholarship, non-qualified withdrawals up to the amount of the tax-free scholarship can be taken out penalty-free, but you’ll have to pay income tax on the earnings. The scholarship has turned your tax-free 529 investment into a tax-deferred 529 investment.
8. Make a non-qualified withdrawal.
The final way you can use your 529 account is making a non-qualified withdrawal. This means that the earnings-only portion of the withdrawal will be taxed on the federal, state, and local level. Like other tax-advantaged saving programs, there will be a 10% federal tax penalty assessed for withdrawing money from the 529 plan for costs that aren’t considered qualified higher education expenses.
As the 529 account owner, you can direct the non-qualified withdrawal to your child who is the account beneficiary. Before you elect to make a non-qualified withdrawal, I suggest you first talk with your financial advisor or tax consultant to evaluate your options.
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