Families are working hard to save as much as possible for the ever increasing cost of their children’s college education. It is hard to imagine having money left over, but this is more common than you may think. Students may attain scholarships, grants, or receive unexpected gifts or inheritance that can leave the 529 plan with more funds than expected. It is important to have a plan in place to manage the possibility of leftover funds.

Here are several options to repurpose the leftover 529 plan funds:

1) Change the beneficiary to another qualifying family member.

You can replace the current beneficiary with another qualifying family member without any taxes or penalty due. A “qualified” family member includes the beneficiary’s spouse, son or daughter, stepson or stepdaughter, siblings, father or mother, stepfather or stepmother, niece or nephew, aunt or uncle, first-cousin, as well as any of their spouses. Keep in mind that you are only allowed to change beneficiaries once per year.

A circumstance where there could be federal taxes charged for changing a beneficiary is known as a “Generation-Skipping Transfer (GST) Tax”. This federal tax is incurred when:

There is a transfer of property by gift or inheritance that passes from a grandparent to a grandchild.

There is a transfer of property by gift or inheritance to a beneficiary who is unrelated and is more than 37.5 years younger than the donor.

The amount received must be in excess of the GST estate tax credit, which in 2016 is $5,450,000. If it does not exceed this amount, there will be no GST Taxes incurred.

2) Hold onto it for future educational needs for the same beneficiary.

One of the great advantages of a 529 plan is that you are not limited to using the funds solely for a bachelor’s degree. Students can apply the funds toward a post-secondary (including vocational or technical schools) graduate or professional degree at a qualified educational institution. Since you are not required to take distributions from a 529 plan by a specific date, you also have the option of leaving it alone for the time being. Even if you don’t make any further contributions, the money that is already in the account will continue to grow tax-free. If you were to die, the successor owner named on your application will assume the decision-making authority over the account.

3) Withdraw it without a penalty using the funds for non-qualified expenses.

In some cases, you can take a non-qualified withdrawal without having to pay a penalty tax on earnings such as when the beneficiary dies, gets disabled, enters the U.S. military or gets a scholarship. In the case of a scholarship, you can withdraw up to the amount of the award to spend on whatever you would like, but keep in mind that you still have to pay income tax on any gains in the account.

4) Withdraw it with a penalty using the funds for non-qualified expenses.

If you really don’t have any use for the leftover 529 plan money, you can always take a non-qualified withdrawal. Since contributions were made with after-tax money they will never be taxed or penalized, but any earnings on your investment will be subject to income tax as well as a 10% penalty. Unlike a Roth IRA, you are not permitted to take a principal-only withdrawal from your 529 plan. When a non-qualified distribution is made, a formula is used to attribute a portion of the withdrawal to the account owner’s original contributions and the remaining portion to earnings. The 529 plan will calculate the amount of each portion for you. Some things to keep in mind regarding non-qualified expenses:

The tax is assessed at your individual rate, rather than the beneficiary’s.

You will have to report the amount distributed as taxable income the following April.

If your debt is student loans, the IRS does not consider them a qualified higher education expense.

5) Use the 529 funds for estate planning.

Another possible use for leftover 529 plan funds is to utilize it as an estate planning tool. The value in the 529 plan is removed from your taxable estate, but you are still able to retain control of the account. The contributions are treated as gifts for tax purposes, which means gifts up to $14,000 per individual will qualify for the annual exclusion.

For more information about federal gift tax rules, please refer to the following article:

A Brief Look Into The Federal Gift Tax Rules

For more information about 529 plan options, please refer to the following articles:

The Better Virginia529 Plan

Virginia529 CollegeAmerica or inVEST?

Carol Chaudet

(last updated 3/31/2016)