Q.: We will not need all the money we have in my son’s 529 plan. What are our options with these funds? Can we use the money ourselves?
A.: Sandy, you have a lot of options. The rules applicable to 529 savings plans are found in Code Section 529. The plans are quite flexible.The owner of the account controls the account, not the beneficiary. Assuming you are the owner, yes, you may take the money out and do what you want with it. Any earnings in the account will be taxable income to you. You will pay an additional 10% penalty if that money is not spent on qualified educational expenses. The taxes apply to earnings only. Contributions were made after tax and are not taxed again. The 529 plan tracks how much of an account balance is attributable to contributions and how much is earnings.
One way to reduce the taxes is to make sure you have taken out as much as you can for tax-favored expenses. “Qualified” expenses include more than tuition. Fees, books, supplies, equipment required for the enrollment or attendance, a computer, peripheral equipment, and computer software all count. Room-and-board expenses qualify, too, up to certain limitations. Under a provision in the recently passed SECURE Act, you may even use up to $10,000 toward student loan debt of your son or any of his siblings. For details, see Section 8 “Qualified Tuition Programs” in Publication 970.
Be aware that the accounting is based on the tax year, not the academic year. For earnings to be exempt from taxation, such expenses must be paid in the same tax year that the distributions are made.
What many families do, instead of taking unused funds and paying those taxes is they simply change the beneficiary to another family member that could use the funds for their education. No taxes occur upon the change of beneficiary. The definition of “member of the family” in this part of the code is broad and includes:
3. Son-in-law, daughter-in-law
Another option that appeals to some families is to simply leave excess funds in the 529 plan to accumulate for future grandchildren. When your son (or other child) becomes a parent, you can name your grandchild as beneficiary. To empower your son to make decisions about the account and for financial aid reasons you could also transfer ownership of the account to him without triggering income taxes.