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Source: The College Investor
The biggest fear of many parents saving for college: What do you do with the money from the 529 plan if your child doesn't go to college?
A 529 plan account is a tax-advantaged savings account for college expenses. You can put money into the account for a designated beneficiary, and the money you invest can grow tax-free. As long as you use the money for qualified education expenses, you won't pay taxes on the growth.
However, if you withdraw the money from the account and don't use it for educational expenses, you'll have to pay a 10% 529 plan penalty on earnings and growth. That sounds like bad news for diligent savers whose kids are skipping college to join the military, enter the workforce, or start a business.
Fortunately, the money in the 529 plan account doesn't have to go to waste. As a parent, there are several ways you can still invest the money in a 529 account that works well for us, many of which can help you avoid the 529 plan withdrawal penalty. Here are some of your best options.
1. Wait a few years
If you don't have immediate plans for the money in your child's 529 account, wait a few years before taking action. Your child could decide to go to college in a few years.
Typically, students begin college a year or two after graduating high school, but not everyone takes that route. Some students hope to gain work experience after high school, join the military, or start a business. By focusing on extracurricular activities for a few years, a young person may begin to see the value of higher education.
By leaving the money in the account for your child, you'll avoid the 529 withdrawal penalty today. And you may still be able to give your child an amazing financial head start when they decide to go to college in a few years.
2. Help a family member pay for college (or pay off student loan debt)
If you have multiple children, having extra money in a 529 account shouldn't be a problem. You can simply change the beneficiary and help another child pay for their college expenses. This is probably the easiest way to avoid the 529 plan withdrawal penalty if you have multiple children who are about to go to college or graduate school.
If all of your other children have graduated from college, you may still be able to help them pay for college expenses. You can avoid the 529 plan withdrawal penalty if the funds are used to pay off student loan debt.
The SECURE Act allowed money from 529 accounts to be used to pay off up to $10,000 of student loan debt per beneficiary and each of their siblings. That means an account with $20,000 unspent could be split between two siblings to pay off $10,000 of student loan debt each.
It's also important to point out that you can transfer the beneficiary of your 529 plan to any “qualified family member” without tax consequences, so if your children can't use the funds, consider transferring them to a niece or nephew, or waiting until you have grandchildren and then making them the beneficiary.
Important NOTE: Not all states follow student loan rules. Find your state in our 529 Plan Guide and check the rules that apply.
3. Use the money for K-12 education
If your children or grandchildren attend private school, you can avoid the 529 plan withdrawal penalty by using the funds to finance their education.
Tuition for private school education from preschool through high school is one of the qualified 529 plan education expenses. Simply change the beneficiary to the child who will use the funds.
Important NOTE: Not all states follow federal regulations for K-12 education.
Related: How to use a 529 plan for private elementary and secondary schools
4. Use the money for qualified training programs
College and private school tuition aren't the only eligible education expenses. You may also be able to avoid the penalty on 529 plan withdrawals by paying expenses for internships or training programs (such as a trade school, certain coding boot camps, or culinary school). You should check eligibility for these programs before giving the money to a beneficiary.
5. Make yourself a beneficiary
The money in 529 accounts is earmarked for educational expenses. If you're in your 40s, 50s, or 60s, you may not view your personal education as a worthwhile financial goal.
But before you make yourself a beneficiary, consider the benefits. If you want to change careers, you could use the money to get a master's degree, a law degree or another qualification that will increase your marketability.
You can use the funds to take interesting courses with world-class professors, even if you're not pursuing a degree. Retirees could use the money to go back to school during retirement. Legally, the funds can cover the cost of their studies as well as basic living expenses.
6. Set up a dynasty or multi-generational 529 plan
Just like you can wait a few years, you can wait MANY years. You can just let the 529 plan funds keep growing and use the money for future generations. That could be a grandchild, a great-grandchild, etc.
Remember that you can change both the beneficiary and the account owner in the future, so if you have extra money in your 529 plan, you can let it continue to grow and be used for future generations. This may also align with your goals: You probably put the money into the account originally to use for education, so let that happen.
Here are complete instructions on how to set up a Dynasty 529 plan.
Can't avoid the penalty for withdrawing from the 529 plan? Don't worry
If you withdraw money from the 529 account and don't use it for qualified education expenses, you'll have to pay a 10% withdrawal penalty on the account's earnings and growth (the 529 plan penalty). A 10% penalty sounds like a lot, but in reality, it's usually a very manageable amount.
Consider a family that put $1,500 into their child's account each year for 18 years. Over 18 years, the parents put $27,000 into the account. By the time the child says he or she doesn't want to go to college, the account is already worth $47,000.
If the parents decide to close the account and give all the money to their child, what is the penalty? The answer is $2,000, or 10% of the increase. The account has grown by $20,000, so the 10% penalty applies to that increase, but not to the original $27,000 the parents contributed.
Note: You'll also be subject to regular income taxes on the earnings (along with the penalty). And some states have clawback provisions that let you get back any tax deductions or credits you may have received.
Ideally, you don't lose any money to taxes. But the penalty doesn't seem so bad when you understand that it only applies to the growth of the account, not the entire account. In many cases, even after accounting for the 10% withdrawal penalty, your 529 plan's performance may not be much worse than a taxable brokerage account.
Final thoughts
Dealing with unused 529 funds can seem like a hassle. However, parents have many options for using the funds for themselves or their children. In many cases, you can avoid the penalty for withdrawing from the 529 plan. But even if you have to pay it, it's really not the end of the world.
Consider your options carefully, and don't be afraid to wait. If you don't need the money now, there may be an opportunity to use it in the future. In the meantime, there's no harm in letting the money grow in the account. And if you're just looking to start saving in a 529 account, here are our favorite brokers for opening a 529 plan.
Create your very own Auto Publish News/Blog Site and Earn Passive Income in Just 4 Easy Steps
