Can there really be such a thing as having too much money in an account? Most of the time, this would be hard to imagine, but when a 529 education funding plan has excess funds and no qualified educational expenses left to pay, it can create a bit of a quandary. Because withdrawals from a 529 education plan are subject to a 10% penalty—plus ordinary income taxes—unless they are used to pay for qualified educational expenses, what do you do with the funds if the beneficiary has graduated or otherwise has no more need for them?
Fortunately, there are some alternatives that can allow the funds to be re-purposed without taking a tax hit. Let’s take a look.
Roth Rollover
With the 2023 passage of SECURE 2.0, it became possible to roll over funds from a 529 plan to a Roth IRA, in effect transforming what was an education funding account to a retirement savings plan for the recipient. There are some stipulations, however:
- the 529 Plan has to be at least 15 years old (for example, opened for a young child who is now a college grad);
- the beneficiary of the 529 Plan must also be the owner of the Roth account;
- the owner of the Roth account must have earned income equal to the amount of the rollover;
- rollovers in any given year cannot exceed the allowable amount for Roth IRA contributions ($7,000.00 in 2025);
- $35,000 lifetime maximum for rollovers.
As we mentioned in a previous article, this can be an ideal option for a newly minted college graduate who is starting out in their career. In fact, they may even be able to withdraw funds from the Roth account penalty-free for purposes other than retirement, such as making the down payment on a first home (regular income tax may apply to the earnings portion of the withdrawals, however).
Change the Beneficiary
If the new grad has a younger sibling or cousin, the owner of the plan can change the beneficiary to allow the remaining funds to be used by the younger person. Also, keep in mind that 529 plans aren’t just for college expenses; they can also be used to pay qualified expenses for private kindergarten, elementary, or prep schools.
Do Nothing
Of course, there’s no requirement to do anything with the funds; you can simply leave them alone and let them accumulate without taxation. It’s possible that a recent college graduate may decide to go back to school for an advanced degree, or even to medical or law school. In that case, the funds in the account could come in handy. Or the plan could be allowed to remain intact long enough for another grandchild—or great-grandchild—to come into the picture.
Other Penalty-Free, Non-Qualified Withdrawal Options
While no one would ever wish for the death or permanent disability of the plan beneficiary, such an event creates the option for penalty-free withdrawal of funds from the plan. But on a more positive note, if a student is accepted into one of the US military academies—where all expenses are defrayed by the federal government—funds may be withdrawn from their plan with no penalty assessed. Also, if a student who is the beneficiary of a plan is awarded grants or scholarships, funds may be withdrawn penalty-free, up to the amount of the financial awards. In this case, however, regular income tax will be assessed on the earnings portion of the withdrawn amount.
If All Else Fails, Just Take the Hit
If none of the above options works, you can always just withdraw the funds, pay the taxes and the penalty, and spend the money on something else. If the former beneficiary of the plan is in a lower tax bracket, it might even make sense to let them pay the tax and penalty out of the proceeds and then use the money in some advantageous way.
Providing the next generation with the right kind of education is a high priority for many of our clients. At Mathis Wealth Management, we want you to be familiar with all your options. If you have questions about 529 plans or other education funding strategies, we can help you find the answers you need. And for more information on education funding, visit our website to read our article, “The FAFSA Is New for 2024–25.”
