529 PLANS: WHAT IF THE BENEFICIARY DECIDES NOT TO FURTHER THEIR EDUCATION?

Opening and funding a 529 plan for beloved one to help pay for future educational expenses is a smart and caring gesture, but what if the beneficiary decides not to attend an educational institution after graduating high school?

Don't worry! Assets in 529 plans always belong to the account owner rather than the beneficiary and there are several options if the beneficiary decides not to use these assets for qualified education expenses:

1) Wait – Leave the funds in the 529 account
2) Change the Beneficiary
3)Rollover the funds to a Roth IRA owned by the beneficiary*
4) Withdrawal the funds from the account (listed last for a reason!)

WAIT

​The funds contributed to a 529 plan by the account owner always belong to the account owner and never expire. Leaving the funds in the 529 for a few years may be a good strategy because the beneficiary could change their mind and decide to attend college or a trade school after a break from school. 

CHANGE THE BENEFICIARY

​If the named beneficiary on the account decides not to use the funds for qualified education expenses, you can change the beneficiary to another family member or yourself. This can usually be done only once a year. The new beneficiary will be able to use the 529 assets just as the original beneficiary would have and there is no penalty for changing the beneficiary.
  
The definition of “family member” is quite extensive including kids, step kids, brother, sister, father, mother, cousins, and more.

There is even the option of naming yourself (the account owner) as the beneficiary. This could be useful if you still have some outstanding student loan debt that needs to be paid off or you yourself decided to attend an educational institution that qualifies as a qualified education expense. 529 plans allow you to use up to $10,000 to repay student loans.

ROLL THE FUNDS INTO THE BENEFICIARY'S ROTH IRA*

Starting in 2024, the recently passed SECURE ACT 2.0 will allow 529 account owners to rollover up to $35,000 of 529 funds to a Roth IRA owned by the beneficiary over the beneficiary’s lifetime if the 529 account has been opened for 15 years.* 

There are certain guidelines that must be followed to execute this rollover:

• The 529 account must be open at least 15 years
• The Roth IRA must be opened in the beneficiary’s name (not the account owners name)
• Rollover amounts are subject to Roth IRA annual contribution limits ($6,500 for 2023) and subject to Roth IRA earned income requirements

 
This option gives the named beneficiary a head start on saving for retirement and a bucket of tax-free money growing over their lifetime. 

WITHDRAWAL THE FUNDS FROM THE ACCOUNT

While simply withdrawing the funds from the account is an option at any time you should tread with caution because there may be tax implications.
 
If not used for qualified educational expenses, any funds that are withdrawn will be subject to federal and state taxes and an additional 10% penalty on the earnings portion.
 
Non-qualified distributions will either be reported as ordinary income on the account owners or beneficiary’s tax return depending on how the distribution is requested. The distribution can be requested to be in the name of the account owner, the beneficiary, or the educational institution. Typically, the beneficiary will be in a lower tax bracket than the account owner, but this isn’t always the case.
 
If the distribution is in the name of the account owner, the account owner will report the distribution on their tax return. If the distribution is in the name of the beneficiary or the educational institution, the beneficiary will report the distribution on their tax return.
 
Be aware that there are some situations where the 10% penalty may be waived on the earning portion but are still subject to ordinary income taxes. The 10% penalty may be waived if the beneficiary dies or becomes disabled, earns a scholarship, attends a U.S. Military Academy, or receives educational assistance through an employer.
 
See our blog post How the South Carolina 529 Plan Works to understand 529 plans in more detail