Q. We will not need all the money we have in my son’s 529 plan. He graduates in May. Yay! What are our options with the leftover funds? Can we roll the money into an IRA or use the money ourselves? — Baily in Suntree
A. Baily, congrats on the graduation! You have a lot of options. The rules applicable to 529 savings plans are found in Section 529 of the U.S. Tax Code. Money is put into the plan, is not taxed as it grows and is not taxed if spent on “qualified” educational expenses. The plans are quite flexible.
Even though you call it your son’s 529 plan I’ll bet you are listed as the owner and your son is the beneficiary. As such, you control the account, not him.
You cannot roll the money into an IRA. That would be a nice boost to retirement savings when the nest empties, but it is not allowed directly. Now, you could take money out and use those funds to fund an IRA or Roth IRA but only if you are eligible to make an IRA or Roth IRA contribution. And, yes, you could just take the funds for yourself and do whatever you wanted to do with them. However, I don’t see many people do that because of the taxes.
When you take money from the account, you pay federal income tax on the earnings distributed and an additional 10% penalty if that money is not spent on “qualified” educational expenses.
The taxes (and penalty if applicable) only apply to earnings. Contributions were made after-tax and are not taxed again. The 529 plan tracks the contributions and the earnings. The plan will report the gross distribution and the amounts of the gross distribution attributable to basis (nontaxable contributions) and the earnings by issuing a Form 1099-Q.
One way to reduce the taxes is to make sure you have taken out as much as you can for tax-favored expenses. Sometimes, people only use 529 funds to pay for tuition, but “qualified” expenses include more than 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.
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. See Section 8 “Qualified Tuition Programs” in Publication 970 for details.
The accounting is based on tax year, not the academic year. For earnings to be tax exempt, such expenses must be paid in same tax year the distributions are made. So, if you pay for any of those things with money from other sources than the 529 plan in 2022, you can at least reimburse yourself for those expenses tax-free.
What I see most often though is instead of taking unused funds and paying those taxes, the owner simply changes the beneficiary to another family member that could use the funds for their education. No taxes occur upon the change of beneficiary. This is one area of flexibility I alluded to earlier. The definition of “member of the family” in this part of the code is broad and includes the owner plus the owner’s:
Son, daughter, stepchild, foster child, adopted child or a descendant;
Siblings or step-siblings;
Father or mother or ancestor of either, stepmother, stepfather;
Aunt, uncle or their spouse;
Niece, nephew or their spouse;
First cousin or their spouse.
Another option that appeals to some families is to simply leave excess funds in the 529 plan to accumulate for future grandchildren. When your son (or other child) becomes a parent, you can name your grandchild as beneficiary.
To empower your son to make decisions about the account and for financial aid reasons you could also transfer ownership of the account to him. There are gift tax implications but the change of ownership does not trigger income taxes.
Dan Moisand, CFP®, is a past national president of the Financial Planning Association and has been featured as one of America’s top financial planners by at least 10 financial planning publications. He can be reached at moisandfitzgerald.com or 321-253-5400, ext. 101.
This article originally appeared on Florida Today: That unused money in a college savings plan: What are our options?