529 plans are tax-advantaged savings vehicles designed to accumulate contributions and help pay for the beneficiary’s qualifying education expenses. Sometimes, 529 plans have unused funds after the beneficiary graduates or decide to discontinue their education. There may be other reasons the funds were not used, such as:
· The beneficiary received scholarships
· The beneficiary used monies from a relative (inheritance) for education expenses
· The secondary education costs less than the 529 plan’s assets
Sometimes, the 529 plan is used only for paying tuition. However, the funds can cover other expenses such as room and board, computers, books, supplies, fees, apprenticeship costs, and equipment for obtaining a degree or certification. Whatever the reason for having unused 529 plan funds, here are five spending options to consider:
#1- Transfer the 529 plan to another beneficiary. The plan can transfer to another qualifying family member without tax consequences. Qualifying family members include the beneficiary’s blood relatives or relatives by marriage and adoption.
#2- Use the money to make student loan payments. The SECURE Act allows families to take penalty-free and tax-free 529 plan distributions to pay off the beneficiary’s student loans or other family members’ loans. Both principal and interest payments toward a student loan are considered qualified education expenses, but some IRS rules apply. Visit your tax professional to help ensure you fully understand these rules before using your unused funds.
#3- Move 529 plan monies to a Roth IRA. When moving 529 plan monies to a Roth IRA, IRS contribution limits apply, and the beneficiary must have earned income up to the amount converted. In 2024, if the 529 plan has been open for at least 15 years, up to $35,000 of those funds (for the beneficiary of the 529 accounts only) can be contributed to a Roth IRA, regardless of the beneficiary’s earning limit.
Here are other IRS rules that apply to moving 529 plan monies to a Roth IRA:
· The roll over cannot include any contributions or earnings on contributions that were made in the preceding five years.
· Beneficiaries cannot roll over any money from their 529 plan into a Roth IRA without incurring penalties and taxes unless the account has existed for at least 15 years.
Before initiating a 529 plan to Roth IRA conversion, visit your financial and tax professionals to determine if this strategy suits your situation and to help ensure you understand these rules.
#4- Take a non-qualified distribution (Cash it out). While you will pay the penalty and taxes on the accumulation in the 529 plan, your contributions are always penalty and tax-free when you take a non-qualified distribution.
#5- Keep the 529 plan. You can keep the 529 plan for future use for the beneficiary, a grandchild, or other family members. There is a timeline for when to use the funds if the beneficiary dies. Then, the 529 plan can be cashed-out with no tax consequences.
529 plans are a time-tested way to save for education expenses. To avoid overfunding, work with your financial professional to determine an appropriate funding amount or consider which spending options suit your situation.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by Fresh Finance.
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