This is a segment of Bautis Financial’s college planning series, which includes webinars, podcast episodes, blog posts and downloadables to aid college-bound students and families in the admissions process. Visit our college planning hub for more valuable resources.
Soon after a child is born, parents begin wondering how they can best position their children to make the most of themselves. For many, college comes to mind. As a parent, you may envision your child attending a four-year school, where they can cultivate their potential and, ultimately, gain the knowledge and skills necessary for future employment.
Because college has become so expensive, many adults hope to help a child they know or love avoid the burden of student loan debt by saving on behalf of the child. One of the most common savings vehicles for this purpose is a 529 plan.
But what happens to the funds in a 529 plan if the child doesn’t want to go to college? If you’re a parent, you know that one of the great things about having kids is that they can surprise you at every turn… so it doesn’t hurt to be prepared should your child opt for a different path.
529 Plan Rules
529 plans were established to provide a tax-advantaged way to save for future education costs. Money saved in a 529 plan generally grows tax-deferred at the federal level, and withdrawals used to pay for qualified education expenses are generally tax-free.
Qualified education expenses include college tuition, room and board, required fees, books and supplies and equipment required for courses. But a 529 plan isn’t just for post-secondary education anymore.
Uses of a 529: Before High School
Thanks to the Tax Cuts and Jobs Act of 2017, families can use 529 plan funds to pay for up to $10,000 in tuition expenses (per beneficiary) at elementary, middle or secondary schools. This includes public, private and parochial schools.
Note that different states may have different restrictions. Please consult with a Certified Public Accountant before taking action.
Uses of a 529: Post-High School Education
While a 529 is generally referred to as a college savings account, assets in a 529 can go toward several different educational pursuits, including qualified two-year associate degree programs, trade schools and vocational schools (at home and abroad) such as culinary arts or mechanical and automotive schools.
If your child chooses to pursue post-secondary training in their chosen field, savingforcollege.com has an easy online tool to help you determine if the particular school qualifies. Generally speaking, a school is eligible if it participates in student aid programs offered by the Department of Education.
Uses of a 529: Student Loan Debt
529 plans don’t have time limits. If there is leftover money in a 529 plan after a student graduates, up to $10,000 of 529 assets can be used to pay off student loan debt.
This change was introduced as part of the 2019 SECURE Act and applies to all 529 plan distributions made after December 31, 2018.
Other Options: Flexibility to Change Beneficiaries
Even if you don’t use the funds in a 529 plan for the original beneficiary’s education, you have the right to change the beneficiary. There are some rules here, though.
- The new beneficiary must be related to the original beneficiary. That list includes:
- Owner of the account
- Son, daughter, stepchild, foster child, adopted child or descendent
- Son-in-law, daughter-in-law
- Sibling, step-sibling
- Brother-in-law, sister-in-law
- Father-in-law, mother-in-law
- Father or mother or ancestor of either, stepmother, stepfather
- Aunt, uncle or their spouse
- Niece, nephew
- First cousin or their spouse
- The funds must be used for qualified education expenses. This way, you don’t incur income taxes or penalties. Again, qualified education expenses include college tuition, room and board, required fees, books and supplies and equipment required for courses.
- Beneficiary changes follow 529 rules. Most 529 plans allow you to change the beneficiary once a year, so the account owner should be aware of the frequency allotted by the plan they hold.
Because a 529 plan never expires, the flexibility here is really great. Say your child, the original beneficiary on the 529 plan, decides not to go to college. You can make yourself the beneficiary if you want to go back to school for an advanced degree, or even to take classes at a local community college. Then, if the original beneficiary decides years down the road that they want to pursue an education, you can transfer the leftover funds back to them.
But the real beauty of changing beneficiaries is that a 529 plan can become a family fund that pays for education costs for generations to come. Being able to name another family member as the beneficiary while maintaining the tax-advantaged status of the investment makes 529s a wonderful wealth transfer tool.
If set up the right way, with the right amount of funding and IRS rules in mind, the 529 could outlast you as it benefits your family for decades to come. Because remember, 529 plans don’t have time limits and the longer funds remain in the account, the longer – and larger – they grow tax-free.
Other Options: Taking the Cash
Cashing out your 529 plan is always an option, but it will cost you both federal income taxes and a 10% penalty on the earnings.
However, there are some scenarios in which the 10% penalty for 529 plan withdrawals is waived. In these, the earnings portion of the distribution is still subject to income tax.
The 10% penalty may be waived if:
- The beneficiary dies or becomes disabled.
- The beneficiary receives a full scholarship to college.
- The beneficiary receives educational assistance through a qualifying employer program.
- The beneficiary attends a U.S. Military Academy.
- The qualified education expenses were used to generate the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC).
Since one of the main benefits of a 529 plan is the federally tax-free earnings, cashing out the funds for non-qualified education expenses is not recommended. Instead, it might be wise to keep the assets in reserve in case the beneficiary changes their mind and decides they want to go to college, or until you name a relative as a new beneficiary.
Begin your journey of mastering the college admissions process with Bautis Financial. Whether you’re a parent or guardian, student or school counselor, book a free consultation to discuss how our financial advisors can be a college planning resource.