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Let’s discuss a dream financial scenario, and no, we’re not talking about winning the lottery, but what follows is an examination of a windfall of sorts.
Assume you’re a parent or grandparent that was prescient enough to set up a 529 college savings account when the beneficiary was born or soon thereafter. As a brief refresher, 529 plans feature several attributes that are likely attractive to a broad swath of clients, including tax-deferred growth, the ability to efficiently change beneficiaries, no federal tax implications and the ability to roll excess funds, up to $35,000, over into a Roth IRA.
Here’s the “dream” part of the conversation: the person for whom the 529 was created earns a scholarship, chooses a less expensive university than previously expected or comes into a windfall from another relative – all of which could result in excess funds in the 529.
That’s good news for everyone involved, parents/grandparents and the student, because there are myriad ways in which leftover 529 capital can be used.
Ideas for Using Excess 529 Cash
With 529s, clients and parents can contribute as much as they want per year, but there are some tax considerations. Namely, a single donor can “only” realize $19,000 annually per beneficiary ($38,000 for married couples) in federal gift tax exemptions. Contributions above that amount are subject to IRS gift tax rules.
What many clients don’t know is that the funds accrued in a 529 account aren’t limited to simply paying college tuition. Excess capital can be used for books, some room and board expenses and technology relevant to the student’s studies. It can also be used for trade school or held so the student can pursue a graduate degree. That’s not the end of the potential uses.
“If your child decides not to go to college or only uses part of the total funds while in school, you can transfer the remaining funds to another family member who is planning to attend college,” notes US Bank Wealth Management. “For example, the account owner can use the funds for any type of higher education, trade school or community college.”
Another important factor to consider regarding excess 529 funds is that there isn’t a hard timeline under a which decision needs to be made, but there are some related issues that clients should be careful of and ask advisors for guidance on.
“While there’s no timeframe for when the money has to be withdrawn, you can only change the beneficiary twice a year, and the new one must be related to the original beneficiary,” adds US Bank. “To ensure account continuity, you’ll also want to name a successor-owner. That way, the account will remain operational even if something were to happen to its initial owner.”
Other Uses for Leftover 529 Funds
Good news: a portion of excess 529 cash can be used to defray the beneficiary’s student loan obligations – a significant perk at a time when so many young people are burdened with high debt.
“If the 529 plan beneficiary has an open student loan balance, you can use up to $10,000 of the leftover 529 funds to pay off their federal and private student loans. You can also use the leftover funds to pay off student loans borrowed by a sibling(s) without having to change the name of the beneficiary,” according to US Bank.
And yes, the person that set up the 529 account can withdraw leftover cash for personal reasons, such remodeling a primary residence. However, there are stipulations that need to be adhered to avoid paying penalties on those withdrawals.
“The non-education withdrawal isn’t penalized if your child receives a scholarship (in other words, the money can be withdrawn to offset the scholarship amount), attends a U.S. military academy, becomes disabled or passes away,” concludes US Bank.