What options do I have for leftover funds in my 529 plan?

​For years families have been using 529 Plans to help fund their children’s education.
 
However, there are times when the funds in these accounts exceed their use. This can happen when beneficiaries decide not to attend college, or they get financial aid/scholarships that cover much of the cost.
 
In the past, non-qualified distributions from 529 Plans (withdrawals for reasons other than education) would see the earnings portion face income taxes & penalties. So in the case of a non-qualified $40,000 excess balance distribution ($20,000 of which is earnings), the owner could be responsible for $9,160 in taxes…ouch! This assumes IRS tax rate of 24%, IRS 10% penalty, California tax rate of 9.3%, and California 2.5% penalty.
 
This huge potential tax hit created a fear of overfunding a 529 Plan beyond its use.
 
It’s important to note that you don’t have to pay IRS taxes or penalties on the portion of a 529 Plan withdrawal that represents original contributions. Taxes and penalties with the IRS are only levied on the earnings portion. State taxes may vary depending on if your state allowed a deduction for the original contribution.
 
Options available for excess 529 Plan balances
529 Plan owners have several options in the event their 529 accounts have leftover funds.

1. Parents can switch designated beneficiaries at any time and continue using the account for qualifying purposes.
2. Account owners can use up to $10,000 of 529 Plan funds to pay off qualifying student loans for their beneficiary.
3. Parents of children who earn tax-free scholarships can also withdraw an equivalent amount from the 529 Plan without the penalties (however, the earnings portion of the distribution will still be taxable). There are other non-education situations that allow penalty-free distributions (but not tax-free).
4. Roth IRA rollover (explained in more detail below)

 
New for 2024: Roth IRA rollover
Beginning in 2024, 529 account owners can transfer excess funds into a Roth IRA for a beneficiary, without tax consequences on the rolled over money. This could be a great way to provide a huge benefit to your chosen beneficiary, in the way of retirement savings versus education funding.
 
There are several conditions which need to be met to allow for this provision:

1. The 529 Plan must have been in existence for at least 15 years (from account opening date to date of the rollover).
2. Funds transferred to the Roth IRA must be in the 529 Plan account for greater than 5 years.
3. There’s a lifetime cap of $35,000 on the Roth IRA transfers (per beneficiary).
4. Annual transfers cannot exceed annual allowable Roth contribution limits.
5. It’s not 100% established yet whether the beneficiary needs to have sufficient earned income to justify the transfer (like the standard contributions rule has).

 
A nice perk is that there are no beneficiary income limits for the Roth transfers, like regular Roth IRA contributions encounter.
 
Feel free to contact us should you have additional questions regarding your specific 529 Plan account.