As families continue to grapple with the rising costs of college education, many are turning to 529 college savings plans as a viable strategy. These accounts allow families to set aside money specifically for college expenses while also taking advantage of tax breaks and compound interest. Preston D. Cherry, a certified financial planner and the founder and president of Concurrent Financial Planning in Green Bay, Wisconsin, highlighted the benefits of starting to invest in a 529 plan at the child’s birth. “If you start [investing] at the child’s birth, then you have 18 years to make money on top of money. And hopefully, that’s enough to outpace inflation of the price of college,” Cherry explained in an interview with CNBC.
The popularity of 529 college savings plans has been on the rise, with families collectively investing $441 billion in such accounts as of the end of 2023, representing a 16% increase from the previous year. According to data from Morningstar, more families are turning to 529 funds to help pay for college, with 35% of families utilizing these funds in 2024. On average, the money from 529 accounts covered about 9% of the total cost of attendance for families.
However, what happens when there are leftover 529 funds that are not fully utilized for college expenses? Cherry outlined several options for maximizing these leftover funds to ensure they continue to benefit the account holder or their family members.
Roll Funds into a Roth IRA
Thanks to Secure Act 2.0, individuals now have the opportunity to roll money from a 529 plan into a Roth individual retirement account without incurring penalties or income tax. This new measure, which came into effect this year, provides savers with more flexibility in managing their 529 accounts. Cherry emphasized the potential benefits of transferring funds from a 529 plan to a Roth IRA, stating, “We, meaning the parents, saved and invested for your college education. We have excess funds that we didn’t use for you, but we still want to benefit your life. So we’re going to roll it over from one compound tax-deferred vehicle, a 529, to another. One pays for your college, the other is an investment into your future retirement.”
It is important to note that there are certain limitations to this option. To be eligible for a transfer to a Roth IRA, the 529 account must have been open for a minimum of 15 years, and there is a lifetime cap on 529-to-Roth rollovers set at $35,000. Depending on the amount of money being transferred, this process may span over multiple years, as the conversion counts towards the annual IRA contribution limit, which for 2024 is $7,000 for investors under the age of 50.
Change the Beneficiary
If it becomes apparent that the original beneficiary of the 529 plan will not require the leftover funds, such as in cases where scholarships or other financial aid cover the expenses, the account holder has the option to change the beneficiary to another qualified family member. This could include a sibling, step-sibling, parent, or other eligible relatives as defined by the IRS. Importantly, changing the beneficiary of a 529 plan does not trigger withdrawal fees or any tax penalties.
Pay Off Student Loans
Another effective use of leftover 529 funds is to allocate them towards paying off student loans. Under the Secure Act of 2019, savers are permitted to use funds from a 529 plan to pay off student loans, up to $10,000 per year for each plan beneficiary and their siblings. This provision offers families a practical way to reduce existing student loan debt using funds that were originally earmarked for education expenses.
Withdraw the Money Outright
As a last resort, families may choose to withdraw the remaining 529 assets outright. Contributions can be withdrawn tax- and penalty-free, while any earnings not used for qualified expenses may be subject to income tax and a 10% penalty. An exception to this penalty applies if the child receives scholarships, allowing for withdrawals up to the amount of the scholarship without incurring penalties.
This flexibility in utilizing leftover 529 funds provides families with various options for optimizing the savings accumulated in these accounts. Whether it involves rolling funds into a Roth IRA, changing the beneficiary, paying off student loans, or withdrawing the money outright, individuals can strategically manage their 529 savings to align with their financial goals and circumstances.