My Child Just Graduated College – Now What Do I Do With This 529 Plan?

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.