Beneficiary Strategies for 529 Plans
May 25, 2023
529 plans can be an attractive vehicle to save for higher education expenses. The plans are tax deferred while invested, and withdrawals that are used for qualifying expense are tax free. Plans can be established from any state or private program regardless of where you live or plan to go to school. With recent tax reforms, 529 plans can now be used to pay tuition for college as well as K-12 at public, private and religious schools.
Now that these plans have been around for many years, however, some people are finding that they now have overfunded 529 plans. What do you do if you over-funded a 529 plan? There are a few strategies to consider:
1. Change the beneficiary
Even after the beneficiary graduates, the owner of the 529 account retains control and can change beneficiaries as many times as the plan allows to a member of the same family. If you have another child or grandchild that can benefit, the easiest solution for excess funds is to change the beneficiary of the 529 account.
2. Plan for Lifelong Learning
A 529 plan can fund many different accredited post-high school education programs. If you have an adult family member such as yourself, your spouse, a mother, father, aunt or uncle that wishes to pursue continuing education of any kind, you may be able to use the excess 529 funds to pay for their pursuits.
You may also choose to keep an overfunded account open for future potential grandchildren. There are no required distributions for 529 plans and you can leave the money in the account for as long as you would like. This would allow you to set the remaining funds aside for future use.
3. Use the funds for penalty free withdrawal options
Most 529 plans offer a few options to withdraw funds and avoid the 10 percent penalty. These options may include disability or death of the beneficiary. Also, if the beneficiary receives a scholarship you may withdraw up to the scholarship award amount and use the money for non-education expenses. Income taxes will still need to be paid but only on the gains portion.
Additionally, under Secure 2.0 you may now rollover a total of $35,000 into a Roth IRA. This will allow the funds to continue growing tax-free.
A few rules apply:
- The 529 plan must have been in place for at least 15 years.
- The value of the rollover from the 529 plan, in any year, counts towards the annual maximum allowable Roth contribution, which is $6,500 for 2023.
- The beneficiary must have earned income in the year that would qualify for the Roth IRA contribution.
4. Withdraw the excess funds and pay the penalties
It is possible to make non-qualified withdrawals from a 529 instead of sending the money to a school. However, the gains on your investments will be taxed as ordinary income with an additional 10% penalty tax.
You might consider making a withdrawal by having the funds sent as a check to your young adult beneficiary already on the 529. The withdrawal will then be reported as their income and taxed at a presumably much lower ordinary income tax rate.
529 plans offer an easy way for many people to save for higher education. Still, they have certain limitations that may not fit every family. As with any investment vehicle, do your research on the right plan for your family and seek advice to help you with the best choice for your unique circumstances.