Can I Access 529 Funds without Penalty if My Child Skips College?

A 529 plan can be an ideal option for families who want to save money to pay for their child’s future college education. All of the money contributed to these plans grows tax-deferred and qualified withdrawals are tax-free. Many states offer tax deductions on contributions. For example, married couples filing a joint tax return in Colorado in 2023 can deduct up to $31,000 in contributions for each child. 

But what if your child decides they don’t want to go to college? 

Until now, families and students with leftover funds trapped in 529 accounts needed to pay taxes on any withdrawal earnings not tied to education expenses, plus an additional penalty. But in December 2022, Congress passed legislation to benefit those who scrimped and saved for years by offering a new option to eliminate federal taxes and penalties if some of the money in these accounts is not used.   

Known as the SECURE 2.0 Act, it enables some of the money saved in 529 accounts to be contributed to a retirement plan for the child.  

Beginning in 2024, up to a lifetime limit of $35,000 in 529 plans not used for education expenses can be transferred into a child’s Roth Individual Retirement Account (IRA) without paying any federal taxes or penalties.  

Special Rules for 529 Plan Rollovers

There are some special rules to take advantage of this option. For example, the amount of money that can be moved from the 529 plan to a Roth IRA will be subject to the Roth IRA annual contribution limits. The maximum contribution limit for 2024 is scheduled to be at least $6,500 currently, with an extra $1,000 allowed for those individuals over the age of 50 with the catch-up limit allowance. The 529 plan beneficiary will also need to have taxable compensation to allow a contribution for that year. 

In addition, the 529 plan must exist for at least 15 years before money can be moved from it to a Roth IRA.  So, for someone who wants to begin this process in 2024, the account with the child as the beneficiary must have been set up no later than 2009. It is not yet clear if a beneficiary change will restart that 15-year clock and more guidance is needed from the IRS or Congress.  

It is also not yet clear if all states will accept this change in the law. You will need to check your state’s law, or you may need to pay state income tax on both the earnings and the original contributions if your state “recaptures” the original contribution deduction on non-qualified withdrawals. 

Accountholders and beneficiaries also cannot roll over any contributions or earnings on contributions that were made in the last five years. 

Other Penalty-Free Strategies for 529 Plan Funds

You can use the following techniques to access 529 plans without the federal penalty if the child does not go to college. 

Use the Money for Other Children or Family Members

If the child you opened the account for does not plan to go to college, consider making a different child the beneficiary, such as one of their siblings, step-siblings, cousins, nieces or nephews, in-laws, children, grandchildren, parents, in-laws, the spouse of any of these or even possibly yourself depending on your relationship! 

The 529 plan account owner may change the beneficiary to a qualifying family member of the current beneficiary at any time without tax consequences by completing a form on the 529 plan’s website. 

Adults may also go back to school to earn a more advanced degree or other credentials that further their career opportunities. In this case, you can make any qualifying member of the beneficiary’s family the new beneficiary of the account to support an adult’s educational goals. 

Pay Down Student Debt

Under the SECURE Act passed in 2019, plan holders can use the funds for student loan repayments for the beneficiary and the beneficiary’s siblings. The bill set an aggregate lifetime limit of $10,000 per beneficiary. This means a family with two children can take out a maximum of $20,000 to pay down their student loans. Secondly, plan holders cannot claim any student loan interest deductions paid with this money. 

However, not all states chose to accept this change in the law. You will need to check your state’s law, or you may need to pay state income tax on both the earnings and the original contributions if your state “recaptures” the original contribution deduction on non-qualified withdrawals. 

Pay for Education Expenses When Children Are Younger

Money contributed to 529 plans are not restricted to a college education. Up to $10,000 per year for each beneficiary can be withdrawn to pay for tuition at a private K-12 elementary or secondary school. 

It can also be used to pay for fees, books, supplies, and equipment required for participation in an apprenticeship program. However, investigate the eligibility of the school or apprenticeship program to ensure your child can use it for their education. 

This is another area where not all states chose to accept the changes to federal law. You will need to check your state’s law, or you may need to pay state income tax on both the earnings and the original contributions if your state “recaptures” the original contribution deduction on non-qualified withdrawals. 

Avoid Making Hasty Decisions

Few people know for certain what they plan to do after graduating from high school. The beneficiary of your 529 funds may not wish to attend college right after graduation, but their plans can change. Therefore, it may be wise to let the money sit in the 529 account for a few years before making decisions. This strategy ensures the funds are still there if your child decides higher education is the best option for achieving their career goals. 

Moneta Can Provide Additional Guidance

If you need help figuring out how to allocate 529 funds or access a 529 account without penalty, turn to the Hadary Team at Moneta. As part of our wealth management services, we show clients how to make the most of various savings plans, including those for education. 

We are an independent, fee-only Registered Investment Advisory (RIA) firm that puts our clients’ needs before our own interests. Furthermore, we take a comprehensive approach to financial planning by looking at all aspects of your financial situation to deliver personalized strategies that help you realize your dreams. 

Contact the Hadary team to learn more about managing educational savings plans. 

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