Navigating Unused Funds in a 529 Plan: Maximizing Your Education Savings

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. Congress created them in 1996 and they are named after section 529 of the Internal Revenue code. These plans come in two basic types: prepaid tuition plans and savings plans, with each state having its own unique plan. While these plans are primarily used for college expenses, life circumstances can change, leaving you with unused funds. Understanding your options when this happens is crucial to avoid penalties and maximize the benefits of your investment.

Understanding 529 Plans

A 529 plan allows earnings to grow free from state and federal taxes when used for qualified expenses. Contributions can not exceed the amount necessary to provide for the qualified education expenses of the beneficiary. There are no income restrictions on either you, as the contributor, or the beneficiary. Many families choose to enroll in multiple Invest529 programs. An account can be opened with as little as $10.

Qualified Education Expenses

The Internal Revenue Code (Section 529) outlines Qualified Higher Education Expenses. Generally, qualified higher education expenses include costs required for the enrollment or attendance at a school (tuition, fees, room and board, books, computers). A qualified, nontaxable distribution from a 529 plan includes the cost of the purchase of any computer technology, related equipment and/or related services such as Internet access. This means any computer and related peripheral equipment. Related peripheral equipment is defined as any auxiliary machine (whether on-line or off-line) which is designed to be placed under the control of the central processing unit of a computer, such as a printer. This does not include equipment of a kind used primarily for amusement or entertainment. Vocational, technical, and graduate schools are eligible educational institutions. Most public, private or religious K-12 tuition expenses are covered by 529 plans.

Flexibility and Control

The money in the account is always yours. Accounts can be closed at any time. An Invest529 account owner may select multiple portfolios, and each portfolio selected creates a separate account. The account owner may not have two of the same portfolios for the same student. You can move funds or change portfolios for your Invest529 accounts through a rollover, transfer or investment option change. An account owner may initiate an investment option change twice per calendar year per student.

What Happens When 529 Funds Are Not Used?

529 plans are quite flexible as there's no time limit on when the funds must be withdrawn from the account. However, there are some tax-related nuances to keep in mind. There is no penalty for leaving leftover funds in a 529 plan after a student graduates or leaves college, but you’ll face a 529 tax penalty and a withdrawal penalty if you use a 529 plan distribution on non-qualified expenses.

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Non-Qualified Withdrawals

Withdrawals from a 529 account that are used for non-qualified education expenses are taxable as ordinary income and, unless an exception applies, are subject to a federal penalty of 10 percent. The earnings portion of a non-qualified 529 distribution (529 distribution used to pay for non-qualified expenses) is subject to a 10% withdrawal penalty. Each state’s tax rules may differ in its treatment of income from a 529 plan, so it’s important to check with your state or consult a tax advisor regarding specific tax consequences taking withdrawals. If you are a Virginia taxpayer, non-qualified withdrawals may require the recapture of prior Virginia income tax deductions.

Exceptions to the Penalty

Some scenarios warrant a waived 10% penalty for 529 plan withdrawals. If part of those funds go untouched because your child received a scholarship, you won't have to pay any penalty on funds equal to the amount of the scholarship.

Alternative Uses for Unused 529 Funds

If your child decides not to go to college, or doesn't use all of those funds up, there are alternative, penalty-free uses for the funds in your 529 plan.

Saving for Future Educational Needs

One of the most obvious ways to use your unused 529 funds is to save them for future educational needs. There are no time constraints as to when you need to make withdrawals on a 529 fund. If your child decides to take time off between their undergraduate and graduate studies, that won't affect your access to those savings.

Changing the Beneficiary

A 529 plan account has one designated beneficiary. A designated beneficiary is usually the student or future student for whom the plan is intended to provide benefits. You can set one up and name anyone as a beneficiary - a relative, a friend, even yourself. However, you can only change the beneficiary twice a year, and the new one must be related to the original beneficiary. There are no tax consequences if you change the designated beneficiary to another member of the family. Account benefits can be transferred to a member of the current student’s family without penalty. Penalties may apply if transferred to an individual who is not a member of the current student’s family. The new 529 beneficiary must be a member of the family to your child - whether by blood, marriage, or adoption. This list includes siblings, stepsiblings, stepparents, cousins, nieces, and nephews. You can even roll over the account to yourself to fund your own continuing education. Since there are no time limits for using 529 plans, you could also hold onto the already established Ohio 529 account for your future grandchildren’s future college costs.

Rollover to a Roth IRA

As of 2024, through a provision of the Secure 2.0 Act, you can roll a portion of the unused 529 funds into a Roth IRA for that 529 named beneficiary. Any unused 529 funds can be rolled over into a Roth IRA. Starting in 2024, beneficiaries will have the option to roll over funds from a 529 plan to a Roth IRA without incurring penalties. This new tax-free distribution will allow any unused 529 funds, subject to certain requirements, to roll over to a Roth IRA for the same 529 beneficiary without incurring any penalty on the earnings.

Requirements for Roth IRA Rollover

There are specific requirements in order to use this new qualified 529 distribution. First, a 529 account must be open for the beneficiary for 15 years. The 529 plan must be open for at least 15 years. Second, the Roth IRA must be for the same beneficiary of the 529. Third, your contributions-also known as the principal-must have been in your Ohio 529 account for at least five years before the Roth IRA rollover. Fourth, you can only roll over 529 funds up to the yearly Roth IRA contribution limit, which is $6,500 for 2023. Fifth, the lifetime maximum 529 amount allowed for the Roth IRA rollover is $35,000. The lifetime limit for the rollover is $35,000 per beneficiary. Note: Roth IRA rollovers do not count against your yearly rollover limit.

Paying Off Student Loans

If the 529 plan beneficiary has an open student loan balance, you can use up to $10,000 of the leftover 529 funds to pay off their federal and private student loans. The 2020 Further Consolidated Appropriations Act allows tax-free 529 withdrawals to pay principal and interest on certain qualified education loans for the original beneficiary of your Ohio 529 account and their siblings. The loan repayment provisions apply to repayments up to $10,000 per individual. This $10,000 is a lifetime amount, not an annual limit. So if one of your children won’t be using their Ohio 529 account, you as the account owner can use it to pay off your other children’s qualified student loans.

Use for K-12 Education

Because K-12 tuition is a qualified higher education expense, some states may offer a deduction from individual state income taxes (Virginia, for example, offers up to a $4,000 deduction).

Transfer to an ABLE Account

Families who have an Invest529 account can transfer funds to an ABLEnow account without incurring any tax or penalty. However, the amount transferred from the Invest529 account may not exceed the annual ABLE contribution limit, including any amounts previously contributed to the ABLEnow account. Both the 529 and ABLEnow accounts must have the same beneficiary, or the new ABLEnow beneficiary must be an ABLE-eligible “Member of the Family” as defined by IRC Section 529A(e)(4). Note that 529 account to ABLEnow account transfers are available up until December 31, 2025, in accordance with current federal law. 529 rollovers to an ABLE (Achieving a Better Life Experience) account are allowed without any penalty, as long as the account is for the same child or another member of your family.

Military Academy Exception

If your child is attending a U.S. military academy, then you can make a non-qualified withdrawal from their 529 account up to the estimated cost of attending the military academy without incurring the 10% federal tax penalty. The earning portion only of the withdrawal will be subject to federal, state, and local taxes.

Special Needs Expenses

529 plans cover certain expenses for a special needs students. The IRS Publication 970 “Tax Benefits for Education,” describes this as “expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible postsecondary school.” You can make a non-qualified withdrawal from the college savings plan based on your child’s disability as long it meets the IRS’ specific definition found on page 53 of the IRS Publication 970.

Managing Your 529 Account

Opening an Account

First, get to know Invest529 and your portfolio options by reading the Program Description. Once you’re ready, click on Open an Account at the top of any page to gather the information you need to get started. After you create an online user profile, you can complete the application for Invest529.

Timeframe for Use

Generally, you have at least 30 years to use your Invest529 or CollegeAmerica account based on either the student’s projected high school graduation date or, if opened after the student’s high school graduation, when the account was opened. For Prepaid529 or Invest529 Tuition Track Portfolio accounts, you have 10 years after the student’s projected high school graduation year to use the account. Invest529, in its sole discretion, may grant extensions of time in which to use an Invest529 account.

Contributing to an Account

An account owner can set up recurring contributions directly to an Invest529 account from a linked bank account or use the Direct Deposit Assistant to have funds sent by their employer and contributed directly to an Invest account. This option is available through the myaccount portal located on Invest529.com. Purchasing additional Tuition Track Portfolio Units is simple. Log in to your Invest529 account and select Manage My Accounts, then One-Time Contribution. After you select the bank account you’d like to use for the contribution, you’ll be able to select your Tuition Track Portfolio account and the amount you’d like to contribute.

Rollovers and Transfers

Funds can be moved from the Tuition Track Portfolio to other Invest529 portfolios. You may move funds from another qualified tuition program into an Invest529 account by completing a Move Funds Request. For rollovers involving another qualified tuition program (QTP) or a Roth IRA, please allow up to 30 days for processing after all required documentation is received. You can upload your supporting documentation or signature pages through your online account. After logging in, select Upload Documents under the Help Desk tab.

Gifting to an Account

Your personal Gift ID can be retrieved from the secure Invest529 online account portal. Once logged in, select the Gift Center link in the main navigation. Invest529 doesn’t charge fees to the giver or the account owner for making contributions through the online Gift Center.

Financial Aid Implications

Like any non-retirement investment or savings, 529 accounts may affect eligibility for need-based financial aid - however, the impact is minimal. For accounts owned by parents and dependent students, the Free Application for Federal Student Aid (FAFSA) assesses 529 assets at about 5.64 percent of the value when calculating the Student Aid Index (SAI) for financial aid eligibility. Accounts owned by other parties will impact eligibility differently. Beginning in 2024-2025, 529 accounts will only be counted as a parental asset if the account is designated for the student. If your student gets a scholarship, you can use the money in the 529 account to pay for qualified expenses not covered by a scholarship or retain the funds for future years.

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