College graduation season is just about over, and graduates now face a host of decisions: do I get a job? Do I go for a graduate degree? Can I move back home with mom and dad?
For some parents, there is another decision to be made: what to do with a leftover 529 college savings plan.
First, a primer: a 529 plan – named after the section of the Internal Revenue Code governing these plans – is a type of college savings plan. Many parents and grandparents fund 529 plans while children are very young.
Contributions to the plan are not tax-deductible, but over time the plans can grow, and any appreciation is tax-deferred. When used to pay for qualified college expenses, withdrawals are federal tax-free. Some states also offer tax advantages to residents.
Any distribution that isn’t for college is subject to IRS penalties on the earnings only – a 10% penalty on top of income tax on the earnings. (Original contributions are not subject to IRS penalty.)
If you find yourself with unused 529 plan dollars:
- Wait to see if the beneficiary of the plan (the student) decides to go to graduate school. If so, the 529 plan can help pay for an advanced degree.
- Name a new beneficiary. A sibling, niece, nephew, even the eventual child of the current beneficiary – as long as the new beneficiary meets IRS requirements as a qualified family member – can use the surplus funds for their own college expenses.
If neither of those options is viable, taking a non-qualified distribution isn’t the end of the world. The beneficiary will likely be in a low tax bracket, making the penalty a little easier to swallow.
Consider it part of their education: IRS and Taxes 101.