What To Do With Left-over 529 Account Money

January 07, 2019

Some financial problems can be good ones to have. This is one of those examples. What happens when you, your child or any beneficiary of a 529 account gets out of college without using all the money in their 529? Don’t laugh – like I said this is a problem, but it’s a good problem to have, and some people actually have this happen.

Here’s a quick review of five different options, depending on your situation:

1. The scholarship exception. If you still have money because the beneficiary qualified for a tax-free scholarship, you can take a withdraw from your 529 plan up to the amount of the scholarship and not pay the 10% penalty, but you will be taxed on any earnings. (remember that you can also use 529 funds tax-free for room and board, books and other fees as well)

2. Hold it for later. Check and see if your 529 Plan requires distributions by a certain age (some do not). The beneficiary can use the money for graduate school or additional education expenses in the distant future if not.

3. Help out another family member. 529 funds can be transferred to another family member without tax implications and used for their higher education expenses, so decide which is your favorite niece or nephew now. A beneficiary’s family member is defined as:

  • Spouse
  • Brother, sister, stepbrother or stepsister
  • Father, Mother or an ancestor (Grandparents)
  • Stepfather or stepmother
  • Son, daughter, brother or sister of the taxpayer/account owner
  • Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
  • Any first cousin of the beneficiary

4. Roll to a better plan. If there is a distribution requirement by a certain age, you could also consider rolling the money over to another plan that does not require a distribution by a certain age. Be aware that you are only allowed to do one rollover in a 12-month period, so choose carefully. And keep in mind that a rollover may have state income tax consequences, especially if you received a state income tax deduction when you made the contribution.

5. Take the cash, pay the penalty. If all else fails and you have no way to use the money for qualified expenses in a way that would help you or someone you care about, there’s always the option to just take the cash. You will have to pay taxes on the gains plus a 10% penalty, so talk with your tax advisor before doing this so you can plan accordingly.

But before you do that, a quick anecdote from my colleague Kelley – her college classmate Holly (not her real name) was awarded a full ride scholarship to college, so her parents withdrew the 529 money to buy her a new car as a reward. Not only did Holly crash and total the car before the summer was out, she ended up losing the scholarship after 3 semesters due to academic performance. Best to wait until everyone in your family is 100% certain they are in the careers they love with no additional out-of-pocket education costs to come before you exercise this option.

I hope that all of your financial problems are good problems like this.