What are your options for unused 529 plan funds?

A 529 plan allows for tax-free earnings and federally tax-free distributions when used for qualified education expenses. But what if your child decides to forgo college or you have money left over in your plan? 

529 plans have an array of options for using this leftover money penalty-free — with some even tax-free at the state and federal levels.

 *Refers to income taxes, and assumes you meet the qualifications for the options (e.g., you change the beneficiary to a qualified family member, your apprenticeship is a qualifying apprenticeship)

Qualified education expenses are broader than you may think

Before exploring other options, make sure you know all the education expenses a 529 can be used for.

More than just tuition — 529 plan funds can be used for a college student’s day-to-day needs, including books, supplies, internet access, software and computers. Room and board (rent/meal plan) may also be qualified expenses for students enrolled at least half time, including for off-campus housing up to the cost of attendance their college sets.

Graduate school, community college and vocational schools — Tuition costs for graduate school and two-year community colleges are considered qualified expenses for 529 funds. Additionally, many vocational schools — including cosmetology schools, culinary schools, technical colleges and electrical trade schools — have the same penalty- and tax-free treatment of 529 plan funds, as long as the program is eligible for Title IV federal student aid.

You can check whether a school is eligible by contacting its admissions office directly or by checking the Department of Education’s federal school code list.

Penalty- and tax-free 529 plan options (federal and state)

Changing beneficiaries— You may change the 529 beneficiary as often as you like, but the new beneficiary must be a qualifying family member of the original beneficiary. This could include the beneficiary’s relatives by blood, marriage or adoption.

For example, if there’s more than one child in the family, the beneficiary can be changed to pay for a sibling’s education.

In some specific circumstances, such as changing the beneficiary from an older to a younger generation, there could be gift tax implications, so be sure to check with a tax professional.

Investment changes

Normally, investment changes to a 529 plan can occur only twice per calendar year. However, an additional investment change is permitted when changing beneficiaries. This is important if the new beneficiary has a different time horizon for using the money.

Federal penalty- and tax-free (state tax treatment can vary)

State tax treatment

While the following four options are federal penalty- and tax-free, state treatment may vary. If your state doesn’t consider the option a qualified expense, the earnings portion of the distributed funds may be subject to state penalties and income taxes.

Additionally, some states recapture the state income tax breaks associated with the distribution. It’s important to work with a tax professional to understand how your state treats these options.

Rollover to another 529 plan — If a qualifying family member already has a 529 plan in place, instead of changing beneficiaries you can roll the 529 funds into their plan. The roll over is penalty- and income tax-free if the plan is within the same state. However, if the new plan is in a different state, some states may treat it as a non-qualified distribution subject to state taxes.

Keep in mind a beneficiary can receive a rollover only once in any 12-month period. And as with changing the beneficiary, gift tax could apply if the rollover is to a 529 with a beneficiary of a younger generation.

K-12 education — You can use 529 plan funds to pay for up to $10,000 per year of tuition expenses at private, public and religious elementary and secondary schools.

Apprenticeship programs — Many of the expenses associated with apprenticeship programs (such as for mechanics, plumbers and electricians) can be paid for with 529 plan funds. These programs, which allow hands-on training while earning a salary, are gaining popularity as an alternative to college.

If the apprenticeship is certified and registered with the U.S. Department of Labor’s National Apprenticeship Act, fees, textbooks, trade tools and equipment will be considered eligible 529 costs at the federal level. To find a qualifying apprenticeship, visit apprenticeship.gov.

Student loans — Leftover 529 plan funds can be used to pay down student debt, up to $10,000 (lifetime limit) per person for the beneficiary and any siblings. It’s important the debt is paid in the year the 529 withdrawal is taken to avoid owing taxes and penalties.

The account owner can also change the 529 plan beneficiary to themselves should they have student debt. This could be helpful if the parent account owner took out a Parent PLUS loan.

Rollover a Roth IRA — Another option is to roll unused 529 plan funds money into a Roth IRA for the 529 beneficiary. Up to $35,000 of unused 529 plan funds can be rolled over.

There are many rules and requirements to complete this rollover successfully. Be sure to work with your financial advisor and tax professional. Please note that while Edward Jones is working on being able to complete a 529-to-Roth IRA rollover, we do not have the capability today.

Penalty free but subject to federal and state income taxes

Scholarships — Parents often cite the possibility of a child’s receiving a scholarship as a reason for not funding a student’s 529 plan. However, scholarships rarely cover the full cost of college, and 529s have flexibility should your student receive one. You can withdraw up to the amount of the tax-free scholarship without incurring penalties.

We recommend taking the distribution in the same calendar year the scholarship is used. Federal and state income taxes will be owed on the earnings but not the principal.

How we can help

A 529 plan offers funding options beyond tuition at a four-year college. For many families, the benefits of these accounts warrant opening a plan for at least a portion of their student’s college savings strategy.

Your financial advisor can explain your options for saving for higher education and help you develop a strategy for managing any leftover funds.