If you're wondering what to do with leftover money in a 529 plan then I must congratulate you! Not only did you wisely save and pay for your child's college education, you've got leftover money to spend.
So many college students graduate with a lot of debt. But thanks to your disciplined savings over the years, your adult children will graduate debt free or close to debt free.
If you're wondering what to do with leftover money in your son or daughter's 529 plan, I've got some answers for you.
What To Do With Leftover Money In A 529 Plan
The great thing about having leftover money in a 529 plan is that you have tons of options and flexibility under Code Section 529.
You as the owner of the account controls the account, not the beneficiary. You can do the following:
1) Take money out and do what you want with it.
Any earnings in the account will be taxable income to you. You will pay an additional 10% penalty if that money is not spent on qualified educational expenses.
The 10% penalty really isn't that big of a deal if you have properly saved the right amount in your 529 plan by age.
For example, let's say you calculated that four years of college would cost $250,000. Therefore, you logically shoot to aim for $250,000 by the time your child is between 18-21 years old. Let's say you end up saving $280,000 due to a bull market and end up spending $250,000. Paying tax on the income plus a 10% penalty is not that big of a deal on $30,000. Presumably, not all the $30,000 is a gain anyway.
The taxes apply to earnings only. Contributions were made after tax and are not taxed again. The 529 plan tracks how much of an account balance is attributable to contributions and how much is earnings. Therefore, you won't have to worry too much about figuring out what you owe yourself.
Qualified Expenses
To reduce the taxes on gains and the 10% penalty, obviously try and spend as much of your 529 plan on “qualified expenses.” Qualified expenses include tuition, fees, books, supplies, equipment required for the enrollment or attendance, a computer, peripheral equipment, and computer software all count. Room-and-board expenses qualify, too, up to certain limitations.
As you can see, “qualified expenses” can be somewhat vague. Let's say you have $10,000 in 529 plan money leftover. You can always buy a couple nice laptop computers along with some software for your child. Once he graduates, you can have him give one to you or a family member or donate.
You could use your 529 plan money to buy a podcast mic and software for media class. Or maybe, you could use some of the money to help your son start his own website, like Financial Samurai. If the expense is in the name of education, it should count.
Under a provision in the recently passed SECURE Act, you may even use up to $10,000 toward student loan debt of your son or any of his siblings. For details, see Section 8 “Qualified Tuition Programs” in Publication 970.
Just be aware that the accounting is based on the tax year, not the academic year. For earnings to be exempt from taxation, such expenses must be paid in the same tax year that the distributions are made.
2) Change the beneficiary of the 529 plan.
If you just have way too much in your son or daughter's 529 plan, then the next logical thing to do is change the beneficiary to another family member. The beneficiary has to be a part of the family tree. It's easy to change beneficiaries so do not worry.
No taxes occur upon the change of beneficiary. The definition of “member of the family” in this part of the code is broad and includes:
1. Spouse
2. Son, daughter, stepchild, foster child, adopted child or descendant
3. Son-in-law, daughter-in-law
4. Siblings or stepsiblings
5. Brother-in-law, sister-in-law
6. Father-in-law, mother-in-law
7. Father or mother or ancestor of either, stepmother, stepfather
8. Aunt, uncle or their spouse
9. Niece, nephew or their spouse
10. First cousin or their spouse
In other words, there are a lot of options, especially if getting an undergraduate degree is not the only college degree a family member plans to get.
For example, it is becoming more common for college graduates to get their Master's Degree. I got my MBA from UC Berkeley because I needed extra skills, knowledge, and credentials just in case I was let go after the 2001 dotcom bubble. I'm glad I went and would have loved to have a 529 plan set up by my parents to pay for it. Alas, I paid the $40,000 myself.
A 529 plan is a great generational wealth transfer tool. It's much better to give education instead of give money to be spent on who knows what. Education is what will set us all free!
3) Leave the money to unborn grandchildren.
If you are a younger parent, you should consider letting the 529 plan build tax-free over time and leave it to your future grandchildren. When your son or daughter becomes a parent, you can name your grandchild as beneficiary.
Obviously, there is a risk that you could die before you are blessed with grandchildren. I had my son at age 39 and my daughter at age 42. Let's say they have kids at age 30. I will be 69 – 72 years old. Since the median life expectancy for males is roughly 78, I would say there is a 40% chance I will never see my grandchildren. So sad!
Related: What Is The Best Age To Have A Baby
To work around the tragedy of not living long enough to see your grandchildren, simply transfer ownership of the 529 plan account to your adult child. The transfer won't trigger income taxes.
4) Convert a portion of the 529 plan into a Roth IRA.
Thanks to the SECURE Act 2.0, the 529 plan becomes more valuable due to the Roth IRA conversion option.
1) Rollovers can begin in 2024. Anything can happen between now and 2024, so stay on top of the latest rules. I'll certainly be updating the date if anything changes.
2) Same beneficiaries. You can't roll over leftover 529 funds to a different Roth IRA beneficiary.
3) Rollover amount is subject to the annual Roth IRA contribution limit. The annual contribution limit is $7,000 in 2024, or $7,500 if you are 50 or older. The Roth IRA contribution limit will likely go up in $500 increments every three-to-five years.
4) Lifetime conversion limit of $35,000. Although $35,000 seems relatively low, my bet is the lifetime conversion limit will increase with inflation over time.
5) The 529 plan must be open for at least 15 years. For those of you who've been delaying opening a 529 plan, here's another reason to start now. You could even open one with a minimum amount of money and then superfund the 529 plan years later. It is unclear whether the 15-year time resets if you change beneficiaries.
Embrace Your Leftover 529 Plan Money
Ideally, you want to save just enough money in a 529 plan to cover the amount of college expense you would like to cover. Paying 100% for college isn't the goal of all parents since it's nice to make children have skin in their education.
However, if you have leftover money in your 529 plan, feel fortunate. It's always better to have too much money than too little. If your children aren't college-age yet, just follow my 529 plan by age guide. Contribute more if you're behind. Throttle your contributions if you're ahead.
Thanks to the passage of the SECURE 2.0 Act, you can now rollover leftover funds to a Roth IRA. The limit is $6,500 per year, or whatever the maximum is at the time. The lifetime rollover contribution is $35,000. Finally, the 529 plan needs to be open for at least 15 years.
There's no better gift we can give our children than the gift of education. Sadly, with the way private university costs are going up, a 529 plan may not be enough to pay for 100% of a college experience. As a result, parents need to find ways to save even more.
Recommendation To Build Wealth
Sign up for Empower, the web’s #1 free wealth management tool to get a better handle on your finances. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.
After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing.
It's good to save and invest in a 529 plan for each child. However, more importantly, make sure you are saving enough money for your retirement!
About the Author
Sam worked in investment banking at Goldman Sachs and Credit Suisse for 13 years. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. He spends time playing tennis, taking care of his family, and writing online to help others achieve financial freedom too.
He started Financial Samurai in 2009 and has grown it to be one of the largest independently owned personal finance sites in the world. You can join 60,000+ others and sign up for his private newsletter here.