You Overfunded Your 529 Plan. Now What?
With college costs going nowhere but up, countless families are scrambling to save money while their children are young to afford those tuition bills later on. Some, in fact, are going as far as to save for college before their kids are even born . But while many families, despite their best efforts, ultimately fall short savings-wise and find themselves borrowing for college as a result, some wind up in the opposite scenario: having too much money for college socked away in a 529 plan .
Of course, it's a good problem to have in theory, and not such an uncommon one. It's often the case that students receive scholarships to attend college, thereby reducing the extent to which their families need to cover tuition and fees. It's also not unheard of for a child to choose to attend community college for a number of years, thus slashing his or her total tuition bill significantly. However, if you're looking at excess 529 funds, you're probably aware that if you use them for non-educational purposes, you're going to get penalized. And that's hardly good.
But worry not. First of all, if your child receives a scholarship, you can withdraw that equivalent amount from your 529 penalty-free and just pay taxes on the gains associated with that sum. And if you're in a different situation where you just plain have too much money in your account, here are some options for using it without having to throw it away.
1. Designate a new beneficiary on your account
Though 529s do come with certain restrictions, one area in which they're quite flexible is the option to designate beneficiaries. Specifically, you can change the beneficiary on your plan at any time without financial consequences, so that if you have an older child whose fund has excess money, you can put that account in a younger child's name instead. The same holds true with extended family -- if you don't need the money for your own children, you can let a niece or nephew use it instead. You can even decide to make yourself the beneficiary and pursue an advanced degree if you so choose.
2. Use the funds for private grade school education
Let's say you have an older child who decides not to go to college, and a younger child with a robust account who's much younger. Whereas it used to be that 529 plans were designed for higher education only, effective this year, you can use them to pay for a private grade school education as well. Therefore, in our example, you can use your older child's untapped money to pay for your younger's child private elementary or high school education.
3. Save the money for your hypothetical grandchildren
There's no limit as to when you have to spend the money in your 529, so if you don't end up needing all of it for your own children's education, and don't have extended family who can benefit from that fund, you can hang onto your balance and save it for when your kids have children of their own. The benefit of going this route is that your money can continue to grow tax-free until you withdraw it.
4. Use the money for non-education purposes
There's a reason 529 plans offer a number of tax benefits : They're designed to encourage families to save for college. As such, if you use the money in your plan for non-qualified purposes (meaning, for something other than education), you'll be penalized to the tune of 10%. That penalty, however, applies only to the earnings portion of your account, and not your principal contributions. Therefore, if you're sitting on extra money in that account and truly have no way to spend it on education, you might as well take a hit on your gains but recoup your principal in full.
Having too much money saved for college is, in some ways, a fortunate predicament to land in. And thankfully, you have several options at your disposal that allow you to use your money without losing some of it to penalties. At the same time, if you're years away from having your children attend college and are therefore still in saving mode, you may want to consider putting some of that college fund into a Roth IRA in your name instead. Roth IRAs offer the same tax benefits as 529s (tax-free growth and withdrawals), only unlike 529s, you're by no means limited to educational expenses. If you use a Roth IRA to save for college and wind up with extra money, you can save it for when you retire and withdraw it penalty-free as a senior.
Of course, Roth IRAs have their drawbacks. You can only contribute $5,500 a year if you're under 50, or $6,500 a year if you're 50 or older, and higher earners can't fund Roth IRAs directly. But if you're worried you'll land in the enviable but tricky position of saving too much for college, divvying up your education fund between a 529 and a Roth might be the best way to go.
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