Years ago, when your children were quite young, you wisely looked at the high cost of higher education (which has gotten higher still) and invested in a 529 plan. And that was a good decision because a 529 plan’s earnings are generally tax free, provided the money is used for qualified educational expenses. But if your first child is now of college age and does not plan to attend college, what should you do with your 529 plan?
First of all, there’s really no need for concern – your investment won’t be wasted. Here are five ways to take advantage of a 529 plan:
1. Change beneficiaries
As the owner of the 529 plan, you can essentially name anyone you want as a beneficiary – another family member, someone you care for, etc. So, if your child opts out of college, you can name a younger sibling or even a niece or nephew or potentially another relative. You can even name you or your spouse as the beneficiary if you’re interested in furthering your education. The process to switch beneficiaries is quite simple and can be done once a year.
2. Use the money for other types of advanced education
Many people think of a 529 plan as just a college funding vehicle, but it’s actually far more versatile. Your child could use the funds to pay for qualified expenses in an apprenticeship program registered with the U.S. Department of Labor. These programs, which are typically offered at trade or vocational schools, provide valuable career-oriented training in a number of fields. To be eligible to use the 529 plan, your child must be enrolled in a trade/vocational school that participates in a student aid program run by the U.S. Department of Education.
3. Pay for qualified K-12 expenses
A few years ago, new legislation made it possible for families to use 529 plans to pay up to $10,000 per student, per year, for qualified K-12 expenses, which typically include tuition and necessary fees. As is the case with 529 plans used for college, your earnings and withdrawals are free of federal taxes if the money is used for qualified expenses. Plus, your state may give you an income tax deduction or a tax credit on your contributions. (However, not all states permit penalty-free withdrawals for K-12 education, so you’ll need to check with your state’s department of education for guidance.)
4. Help pay off student loans
You can now use your 529 plan proceeds to help pay off federal or private student loans. A $10,000 maximum lifetime limit applies for a beneficiary and each sibling. If a student has two siblings, and they all have student loans, up to $30,000 can be withdrawn without taxes or penalties to pay down these debts. However, no more than $10,000 can be applied to an individual student’s balance. You must make the loan payment in the same year you withdraw funds from your 529 account. Of course, this benefit might not be relevant to you if none of your children pursue any form of higher education, but you may be able to use your 529 plan to help pay off some of your own student loans, or those of your spouse, if either of you still carry these debts. As is the case for K-12 expenses, though, you’ll have to check with your state to determine if student loans count as a qualified expense that can be covered by a 529 plan.
5. Leave the account intact
A child who may not want to go to college one year may decide to do so in the future, so you can keep your 529 plan intact until the child does use it for qualified education expenses. Or, as described above, you can switch beneficiaries. You could even leave it for future generations – contributions to a 529 plan are generally considered completed gifts for tax purposes and are removed from your estate.
Avoiding the 10% penalty
As mentioned, one of the biggest benefits of a 529 plan is that earnings and withdrawals are tax free, provided the money is used for qualified education expenses. But if the money is used for anything other than these expenses, you’ll likely pay income taxes and a 10% penalty on your earnings. We’ve already discussed ways to use your 529 plan, and avoid taxes and the penalty, if the child you had in mind chooses not to attend a traditional college or university. But here’s another scenario: What if that child does go to college but doesn’t need the money you’ve set aside in the 529 plan?
Specifically, what happens if your child gets a sizable scholarship? Is your 529 plan simply “stranded”?
Not entirely. The rules governing 529 plans may allow you to withdraw up to the amount of the scholarship without having to pay the 10% penalty. (You’d still have to pay taxes on the earnings, however. The taxes are calculated in such a way that a portion of each withdrawal is considered to be from principal, with the other part coming from earnings.)
However, you may be able to find a less taxing outcome. If your child’s scholarship only covers tuition, you can use the 529 funds, tax free, to cover the cost of room and board. In fact, if your child lives off campus, the 529 money can be used for housing costs, up to the school’s allowance for room and board. And you can also make tax-free withdrawals for textbooks, fees and other required supplies, such as a laptop.
But even if your child doesn’t need all the funds for college, you don’t have to liquidate the account and take a tax hit – there’s no “use it or lose it” rule for 529 plans. If your child only uses some of the funds for undergraduate courses, the rest could be used to cover graduate school costs. Or you could change the beneficiary to another family member.
To ensure you understand all the tax-related issues of a 529 plan, consult with your tax advisor. And your financial advisor can help you determine how a 529 plan can fit into your overall financial strategy. It’s a valuable tool for helping any number of your family members explore the educational opportunities that can lead to a promising future.