Three Options When You Have Excess 529 Funds

in Education-RSS, Financial Planning, Personal Finance Essentials by

Paying for your child’s education is one of the largest financial mountains your family will have to climb, but opening a college savings account is a great starting point. One of the most common and popular savings vehicles is the 529 plan. In fact, of families who have not opened a 529 college savings plan in 2016, 62% intend to open one – a huge jump from the 52% in 2015.

For most, one of the biggest challenges of saving for college is determining exactly how much that will be. There are so many unknown factors when it comes to calculating this number. The cost of college is rising each year. Your child may start at community college and then transfer to a university. They may be awarded a scholarship. Or they may just forego college altogether! There really is no telling what the magic number is when it comes to contributions to your 529 account. In some rare cases, a few meticulous savers find themselves in the extraordinary position of having more money saved than they actually need.

The question remains: What do I do with the excess funds?

Luckily, you have a few options for the unused money in your 529 accounts:

  1. Get creative and use itOne of the great things about 529 plans is that they’re not just for tuition. You can use the funds in this plan for ANY education-related expenses. That includes books, housing, computers, and even Wi-Fi!

    Your student can also use the funds to cover classes at any eligible institution — any college, university, vocational school, or other postsecondary educational institution — that is qualified to participate in a student aid program administered by the U.S. Department of Education. With that said, you might want to also consider saving those excess funds to pay for their graduate school or continuing their education through personal interest classes in the future.

  2. Keep it in the familyIf you’ve overfunded your student’s 529 plan, one option is to simply change the beneficiary. There are no tax consequences for changing to another family member. This can be nearly anyone else related to the child, such as siblings, parents, grandparents, first cousins, aunts, and uncles.

    The only caveat is you can only transfer within the same generation or one generation up. This means that if you’ve overfunded your son’s college, you can transfer the excess by changing the beneficiary to your daughter’s name, OR you or another family member in your generation can become the beneficiary of the plan and use the funds toward continuing your education – a great idea for empty-nesters!

  3. Bite the bullet and close the account
    While this isn’t the most tax-optimal choice, the beauty of a 529 account is there is no “use-it-or-lose-it” rule. The money you contribute is always yours to withdraw; however, you will owe ordinary income tax on the earnings (never on the deposits) if the money is used for non-education related expenses and you will be subject to a 10% penalty on the amount included in income.You can avoid the 10% penalty if your child earns either tax-free scholarships and grants, veteran’s educational assistance, employer-paid educational assistance, or attends a U.S. military academy. In those cases, you can withdraw the funds and only pay tax on the earnings while avoiding the penalty.

    Before you choose to withdraw your funds, double-check what kind of plan you have. Some prepaid tuition plans — which allow parents to purchase college credits at current rates – may only allow you to withdraw the principal invested in the plan. This means that you would lose out on any earnings.

    Additionally, there is a small possibility that your 529 plan decreased in worth due to poor investment management or a downturn in the market. In this situation, you won’t owe tax or the 10% penalty and may be able to claim the loss on your tax return. However, you can only claim a loss after all amounts from the account have been distributed and the total distributions are less than your total contributions to the 529 plan.

Our Takeaway

When you’re planning to save for college, it is important to know much you plan to save. If you are planning on funding your children’s entire college costs, we generally recommended to use 529 accounts for most of the funding (about 75% of the total estimated cost) and fund the remainder (about 25%) with another account type such as a UTMA, a joint account in the parent’s name, or taking out loans. You may lose out on some tax benefits of the 529, but you forego the consequences of closing out an overfunded 529. In the end, if you overfund the plan, the options are pretty straightforward: squeeze as much out of the plan as possible, update your beneficiary, or simply close it out. Schedule time with your financial advisor to discuss your specific college savings strategy and account balances.

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Jacob Jaegle

Jacob Jaegle

Jacob has nearly 10 years experience in the financial services industry and is a Certified Financial Planner®. Prior to working at Personal Capital, Jacob held roles with both a community bank as well as a private trust bank assisting high net worth clients with their banking, lending and investment management needs.
Jacob Jaegle

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One Response

  1. Diana

    You can leave the funds in the 529 account and decide later on how you want to spend it. If your child wants to further their education by taking outside courses, they can use the funds from this account. The funds can also be passed down to use for your grandchildren’s education.

    Reply

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