“A good person leaves an inheritance for their children’s children…”
Any father or mother who has listened to their child’s heartbeat, cradled their newborn baby in their hands, or looked into their son or daughter’s eyes for the first time has likely wondered: “What amazing things are waiting in store for you? How can I make sure you have the best life possible?”
As your child grows up and out of diapers, you’ll have to navigate a complex world of parental choices and challenges… including their educational future. And when it comes to safeguarding their ongoing learning, all the way up to college and beyond, there are few better investment options than a state-sponsored 529 plan.
You might already have taken the proactive, wise step to invest in a 529 fund to cover your son or daughter’s prospective college education, either in part or in full. But what happens if they graduate with money left over? What should you do with unused 529 funds?
This article will comprehensively demystify the five ways you can divert unused 529 funds for your children’s continued benefit — such that the money you have set aside for them continues to support the future you always dreamed they could have.
Where Do Unused 529 Funds Come From?
Before we address the main question, however, it’s worth setting out exactly (i) what 529 plans are, (ii) how they are meant to be used, and (iii) in what situations you could end up with a surplus of funds.
In short, 529 plans are tax-free savings or investment funds with a named beneficiary (your child) that can be used to pay for qualified education costs. There is no time limit for their use, but generally speaking, you should use the funds in the plan for the following qualified expenses:
- College tuition;
- Accommodation costs (whether on or off campus);
- Required books and supplies (e.g. those on course reading lists); and
- Required technology (e.g. laptops, computer software needed for a course).
So when might you have an overfunded 529 plan? Here are the main scenarios:
- If your son or daughter was awarded an unexpected scholarship that lowered the cost of their tuition below what you set aside in the fund;
- If your child opted for an in-state rather than out-of-state college, resulting in lower fees;
- If your child decided to attend a military academy instead of a typical college, such that the military paid for their education instead;
- If they graduated earlier than the expected four-year Bachelor’s degree timeline (and therefore faced a lower bill for the time spent in education);
- If they received an unexpected gift or inheritance from a grandparent or other relative, such that more money was placed in the 529 fund than they ended up needing;
- If your son or daughter decided not to go to college at all, or dropped out early, rendering the original design of the 529 plan (funding their college education) irrelevant; and
- If your child passed away suddenly and tragically, or had an accident that stopped them from attending college temporarily or even permanently.
Impacting the Next Generation
Now that we’ve solved the first mystery — “Where do unused 529 funds come from?” — we would like to offer you an encouraging perspective on how best to move forward if you find yourself in one of the above situations.
Unused 529 Funds: A Generational Asset
Straight off the bat, let us state: 529 funds need not be limited to your kids’ college years, or to the college environment. At the purest, deepest level, a 529 fund represents an investment in your child’s future. In other words, the fact that most 529 plans are only used for college education costs is incidental and non-binding.
Just because something unexpected happened that changed your child’s college trajectory does not mean the money will go to waste. The funds you set aside for them can still fulfill your original intent: providing a springboard for the next generation. You are free to take the heart of your decision and apply it in other, creative ways.
5 Ways to Reallocate Unused 529 Funds
With that mindset front and center — ensuring this source of generational wealth continues to serve your family’s financial objectives for years to come — let’s explore five practical ways you can embrace a new purpose for unused 529 funds.
Option 1: A New or Different Educational Paradigm
Perhaps the most obvious way to redirect unused 529 funds is for your beneficiary child’s graduate school education. This is just as eligible as a qualified educational expense as an undergraduate degree. To follow on from the examples above, this might be a perfect next step if your child was awarded a scholarship, graduated early, or chose an in-state college.
Equally, if your child decided college wasn’t for them or dropped out partway through, but wanted to pursue a different career path, you could put the remaining unused 529 funds towards certified vocational training. Across the US, there are many accredited schools for careers in carpentry, cosmetology, graphic design, automotive repair, plumbing, etc. The list goes on and on!
This way, you can show your son or daughter how much you are willing to support their dreams, whatever those might be.
Option 2: Transfer to a Sibling or Relative
529 plans allow for the transfer of funds to a beneficiary’s family member, with few tax consequences. This includes siblings, cousins, and even the next generation of the nominee’s family (though note the potential GST implications on transfers to grandchildren above a certain threshold — it would be best to talk to your financial planner about this).
By taking the family option, you can provide the same educational leg-up to another cohort, reinforcing the legacy of your initial investment. The only caveat is that you are only allowed to change the named beneficiary twice a year.
As with Option 1, you need not use the funds for traditional college expenses, either: 529 rules allow for funds to be used on anything from kindergarten up to 12th-grade education, with withdrawals of up to $1,000 per year per relative of the original named beneficiary.
So if your eldest (the original beneficiary) has graduated from tertiary education with money left over, you could immediately redirect it towards their younger siblings, or even towards your own siblings’ children (your nieces and nephews).
Option 3: Rollover into a Roth IRA
A less traditional strategy — but one that is gaining considerable traction after new laws passed by Congress came into effect in 2024 (the SECURE 2.0 Act) — is to roll over unused 529 funds into a Roth IRA.
While this requires some careful financial planning, consideration, and consultation with your financial advisor, it can offer another way to provide tax-free investment growth, and to ensure that your kids will be looked after even in their retirement: talk about a long-term perspective!
Without going into too many details (those would be best saved for a conversation with a financial professional), this option comes with a few ground rules for the rollover process:
- Before you can initiate the rollover:
- The 529 plan must have existed for at least 15 years already;
- Each amount that you want to transfer to the Roth IRA must have been put into the 529 plan at least 5 years before the rollover; and
- The 529 plan and Roth IRA must have the same beneficiary (i.e. you cannot imitate option 2 and set up a Roth IRA for the original 529 plan beneficiary’s sibling instead).
- The amount you can roll over from the unused 529 funds must be at least equivalent to the amount of earned income the beneficiary receives in their normal working life, independent of the rollover (i.e. your adult child cannot earn less than the amount you want to transfer to a Roth IRA); and
- As of 2024, the total lifetime rollover is $35,000, with a yearly limit of $7,000 (so in theory you could reach that limit, assuming maximum contributions, within 5 years).
Option 4: Student Loan Repayment
Much like the option to roll over a portion of the unused 529 funds into a Roth IRA above, this fourth option is possible because of the provisions of the SECURE 2.0 Act, which allow for leftover amounts to be used to pay off both federal and private student loans.
As with the Roth IRA option, this isn’t a free-for-all, no-strings-attached pathway: you are only allowed to transfer up to $10,000 per beneficiary for loan repayments. However, unlike the Roth IRA option, you can also transfer the same amount — up to $10,000 — for your other children’s loan repayments, too (i.e. the 529 plan beneficiary’s siblings).
If you redirect unused 529 funds in this way, you could help all of your kids have a debt-free start to their professional lives. Instead of worrying about inflated student loan debt, they could put their unfiltered focus on discovering and developing their unique vocations. In other words: exactly what most parents would hope for their children after college.
Option 5: Non-Qualified Withdrawals
There’s a reason this option is the final one: it has the least obvious connection to the original goal of a 529 plan (providing for your son or daughter’s college education). It’s also true that when making non-qualified withdrawals — withdrawals that are not education-related and are not covered through any of the alternatives above — your children will incur penalties and extra income tax.
Specifically, non-qualified withdrawals incur a 10% penalty on earnings from the account, and this earnings portion will be treated as part of your child’s normal income and subject to income tax. This latter point is worth highlighting to make sure you do not unknowingly bump up your child’s tax bracket!
These penalties are applied pretty stringently, with only a few, very specific exceptions. As we laid out in the first section of this blog post, two tragic situations might result in unused 529 funds: if your child dies or becomes disabled to the extent that they cannot attend college.
In this sad scenario, the government will allow you to withdraw the equivalent amount in savings without incurring a penalty. The same is also true if your child chooses to attend a military academy instead of a typical college.
With all of that said, if you take this option for any of the other reasons (surprise scholarship, extra inheritance gift, in-state college, etc.), then we would encourage you to bear in mind why you put money in the 529 plan in the first place: setting your child up for flourishing and success.
So although you could hypothetically use the unused 529 funds on anything, why not put them toward your son or daughter’s wedding costs, mortgage payments, or even toward support for their future baby? In this way, you might not be supporting their education, but you can still help to bring their other, equally meaningful dreams to life.
Final Thoughts
The five strategies provided above are by no means a one-size-fits-all solution, but rather a starting point for exploring how best to serve your child’s future. Each family’s financial situation and legacy aspirations are unique, so you will need to think through what best suits your situation, and seek tailored financial advice advice as appropriate.
As you do, remember to keep that world-changing feeling — the feeling of looking into your child’s eyes for the first time — with you, whichever way you decide to go.
If you are based in any of the Greater Pittsburgh, Grove City, Greenville, Erie, Cranberry Township and Boardman, OH areas, and you need help thinking through the financial implications of unused 529 funds, why not schedule an appointment with Iron Point Financial today?
Further Resources
- The Biden Loan Forgiveness Plan: 5 Important Implications
- The Secure 2.0 Act of 2022: What You Need to Know
- Financial Stewardship: What it Means and Why It Matters
Disclosures
The opinions contained in this material are those of the author, and not a recommendation or solicitation to buy or sell investment products. This information is from sources believed to be reliable, but Cetera Advisor Networks LLC cannot guarantee or represent that it is accurate or complete.
Before investing, the investor should consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan.
