Q: We will not need all the money we have in my son’s 529 plan. What are our options with these funds? Can we use the money ourselves?
A.: Sandy, you have a lot of options. The rules applicable to 529 savings plans are found in Code section 529. The plans are quite flexible.
The owner of the account controls the account, not the beneficiary. Assuming you are the owner, yes you may take the money out and do what you want with it. Any earnings in the account will be taxable income to you. You will pay an additional 10% penalty if that money is not spent on qualified educational expenses.
The taxes apply to earnings only. Contributions were made after tax and are not taxed again. The 529 plan tracks how much of an account balance is attributable to contributions and how much is earnings.
What’s the difference between a 401(k) and a Roth 401(k)?
One way to reduce the taxes is to make sure you have taken out as much as you can for tax-favored expenses. “Qualified” expenses include more than tuition. Fees, books, supplies, equipment required for the enrollment or attendance, a computer, peripheral equipment, and computer software all count. Room and board expenses qualify too, up to certain limitations. Under a provision in the recently passed SECURE Act, you may even use up to $10,000 toward student loan debt of your son or any of his siblings. See Section 8 “Qualified Tuition Programs” in Publication 970 for details.
Be aware that the accounting is based on tax year, not the academic year. For earnings to be tax exempt, such expenses must be paid in same tax year the distributions are made.
What many families do, instead of taking unused funds and paying those taxes is they simply change the beneficiary to another family member that could use the funds for their education. No taxes occur upon the change of beneficiary. The definition of “member of the family” in this part of the code is broad and includes:
2. Son, daughter, stepchild, foster child, adopted child or a descendant
3. Son-in-law, daughter-in-law
4. Siblings or stepsiblings
5. Brother-in-law, sister-in-law
6. Father-in-law, mother-in-law
7. Father or mother or ancestor of either, stepmother, stepfather
8. Aunt, uncle or their spouse
9. Niece, nephew or their spouse
10. First cousin or their spouse
Another option that appeals to some families is to simply leave excess funds in the 529 plan to accumulate for future grandchildren. When your son (or other child) becomes a parent, you can name your grandchild as beneficiary. To empower your son to make decisions about the account and for financial aid reasons you could also transfer ownership of the account to him without triggering income taxes.
If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line.
Dan Moisand’s comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.