Key Questions: I Have a College Graduate Now, What Can I Do With My Excess 529 Account Funds?

Last weekend, I saw many social media posts from kids going to prom and proud parents of recent college graduates. What if you are lucky enough to still have funds left in that 529 account after your child's graduation? Prior to recent changes, options were limited. Because of the limited options, some parents were against overfunding a 529 account. I will share some current strategies to consider to draw down those excess 529 plan funds.

Roll Over to Another Beneficiary

Maybe you want more investment choices or lower fees. Consider a rollover to another beneficiary’s plan (or the same beneficiary, just a different plan provider). A rollover is the process of moving 529 funds to a different plan. You can roll over to a 529 plan of another member of the family without deeming this transaction as a nonqualified distribution. There is a list of who qualifies as a family member. IRS Publication 970, Tax Benefits for Education, has a list of qualified family members. For these purposes, the beneficiary’s family includes the beneficiary’s spouse and the following other relatives of the beneficiary:

• Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them
• Brother, sister, stepbrother, or stepsister
• Father or mother or ancestor of either
• Stepfather or stepmother
• Son or daughter of a brother or sister
• Brother or sister of father or mother
• Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
• The spouse of any individual listed above
• First cousin

It can be a direct or indirect rollover, and the IRS allows one tax-free 529 plan rollover per beneficiary in a 12-month period for indirect transfers (deposited within 60 days). This is similar to the IRA once-per-year rollover rules. It is important to coordinate with other family members to not run afoul of this rule, or you risk the distribution being deemed nonqualified. Not all states follow the federal treatment for 529 plan rollovers. Also, the rollover could be considered a nonqualified distribution, subject to state income tax and recapture of any previous state income tax deductions or credits. Check with your specific plan.

Roll Over to an ABLE Account

The 2017 Tax Cuts and Jobs Act introduced the limited transfer from a 529 account to an ABLE (Achieving a Better Life Experience) account. ABLE accounts are a savings option for certain individuals with disabilities (when the disability appeared before age 26). Funds are used to improve the beneficiary’s health, independence, or quality of life; earnings aren’t taxed; and eligibility for means-tested government programs won’t be affected.

You can roll over to an ABLE account for the benefit of the same beneficiary or for the benefit of another member of the family. (See the same list above.) The amount you can roll over has an annual contribution limit of $18,000 (2024 limit) when added to other amounts contributed.

Both types of accounts are designed to set money aside for children in tax-advantaged ways. Earnings grow tax-deferred, and withdrawals, if spent on qualifying expenses, are also tax-free.

Make a Beneficiary Change

You can also change the beneficiary within an existing 529 plan to any qualifying member (see same list above). As long as you follow all the rules regarding 529 plan beneficiary changes, you can change the beneficiary as many times as you like. There aren’t any tax consequences for changing beneficiaries when the change is done correctly.

Transfer to Another 529 Account

You can transfer funds from one beneficiary to another qualifying family member within the same plan. You can complete as many transfers you like within a 12-month period.

Roll Over to a Roth IRA

Beginning in 2024, as a result of the SECURE Act 2.0 (Setting Every Community Up for Retirement Enhancement of 2022), you can roll over from 529 accounts to Roth IRAs, under certain conditions. It must be a direct trustee-to-trustee rollover, no checks. There are many limitations to prevent abuse. You can transfer up to a lifetime maximum of $35,000 into a beneficiary’s Roth IRA (must be the same beneficiary of the 529 account), and the 529 account must have been active for 15 years. Contributions to the 529 plan within the last 5 years are ineligible to be rolled over. Note that this rollover won’t be subject to an income limitation (like regular Roth IRA contributions), but it would still require the child to have compensation (summer job or part-time job with income).

Pay Down Student Loans

SECURE Act 2019 allows 529 plans to be used to repay student loans. Up to $10,000 (lifetime limit) can be distributed tax- and penalty-free to repay qualifying federal and private student loans of the beneficiary and each sibling of the beneficiary. Check to make sure the client’s state conforms to the federal provisions (especially recent tax law changes). Some states do not allow 529 funds to be used to repay student loans. While taxpayers would still benefit from tax- and penalty-free distributions at the federal level, they may be responsible for state income taxes on the earnings portion of any distributions deemed nonqualified.

Make a Withdrawal for Nonqualified Expenses

You can always consider making a nonqualified distribution and paying the tax and a 10% penalty on the earnings. The penalty doesn’t apply if the withdrawal is for noneducational reasons and a beneficiary receives a scholarship. 

If you make a nonqualified distribution and the account owner/contributor previously benefited from receiving a state income tax deduction, an issue that may come into play is state income tax recapture. Most states have recapture provisions, but they each calculate it a bit differently, so it is best to carefully research each plan's recapture provisions.

Keep the Funds in the 529 Account

There is no limit on how long you can keep the money in an account. Unlike a Coverdell Education Savings Account, in which you are required to withdraw all the funds by the beneficiary’s 30th birthday, you can keep the 529 of the older siblings open (even with a minimal balance) so that they can receive any future excess funds from younger siblings and be able to still meet the 15-year test if they want to do a future 529 to Roth IRA rollover.

For more information, please contact your advisor.