If you have a 529 College Savings Plan, and your child is not planning to attend college, don’t panic! In most cases, withdrawals from a 529 plan that are not for qualified educational expenses are subject to a 10% penalty and taxes on earnings. However, the good news is that there are a variety of ways to use the 529 plan, and if you do need to make a withdrawal, the penalties and taxes may not be as severe as you think. In this article, we’ll cover all the possible ways to use your 529 College Savings Plan aside from a traditional university degree.
Option 1: Use the Funds for K-12 Education and Post-secondary Training
One of the most common misconceptions about the 529 College Savings Plan is that it is a college or university savings plan. A more appropriate name would be “educational savings plan.” Up to $10,000 each year can be used for kindergarten through twelfth-grade tuition and expenses. In addition to primary and secondary schools, you can use a 529 plan at any post-secondary institution eligible to participate in federal student aid programs.
Eligible postsecondary institutions include community colleges, trade schools, and certificate programs. There are even several golf academies in California that are eligible for the 529 Savings Plan. If your child is decided about not attending university, discuss other career options that require further training, such as cosmetology, massage therapy, and certificate programs like those for computer repair and IT.
To quickly determine if a school is eligible for 529 funds, use the Department of Education School Search tool on the FAFSA website.
Option 2: Transfer the 529 Plan to An Eligible Beneficiary
Funds in a 529 College Savings Plan can be transferred to a family member of the beneficiary once per year with no consequences. The list of family members includes parents, grandparents, aunts, uncles, step-relatives, in-laws, children, spouses of the relatives mentioned above, and first cousins. If the beneficiary lives with an individual for a majority of the tax year, this person may also be eligible to receive funds even if the individual is not a family member.
If the beneficiary has a change of heart, you can convert the account back to the original beneficiary.
Option 3: Disability and Special Needs
Many parents began a 529 College Savings Plan as soon as their child is born, only to discover that their child has a disability and may not attend college. You can convert a 529 plan to a different type of tax-advantaged account called an ABLE (acronym for Achieving a Better Life Experience) account. These funds can be used for qualifying expenses and do not affect Medicaid benefits.
Option 4: Extenuating Circumstances
Usually, withdrawals from a 529 plan that are not used for eligible educational expenses are subject to a 10% penalty, but there are some instances in which the penalty is waived. In each of the following cases, the 10% withdrawal penalty is waived, but you must still pay income taxes on the earnings portion of the withdrawal.
If the beneficiary attends a military academy, you can withdraw the funds without penalty.
If that the beneficiary earns a scholarship, you can withdraw up to the amount of the scholarship award penalty free.
If the beneficiary dies, the account holder can withdraw the money without penalty. You can also transfer the account to an eligible relative of the beneficiary who can use the funds for qualified education expenses.
If the beneficiary is diagnosed with a disability, you can withdraw money from the account to pay for some expenses related to the disability. You can also convert the account to an ABLE account.
Option 5: Transfer 529 Plan to Beneficiary
Some parents choose to transfer ownership of the 529 College Savings Plan to the child, especially if it contains contributions from relatives and friends. In this case, the beneficiary can decide to save the funds for a later time or make an early withdrawal. If account ownership is transferred to the beneficiary, they will be responsible for paying taxes on any withdrawals.
However, if there’s a chance that your child may use the 529 plan at a later date, it may be wise to retain ownership of the account. When a beneficiary is also the owner of their 529 plan, the account is counted as an asset by FAFSA and could increase the EFC (Expected Family Contribution). When the parent is the account holder, the effect on EFC is drastically reduced.
Option 6: Make a Withdrawal
Though a 529 College Savings plan can be used for a variety of educational opportunities, and even disability expenses, it cannot be used to pay funds in the event of personal hardship (unemployment, medical bills, financial hardship) without penalty.
A common misconception about 529 college savings plans is that the entire portion of the withdrawal is taxed. Because you make 529 contributions with after-tax dollars, they are not taxed. If you make a withdrawal for non-eligible expenses, you are subject to a 10% penalty. The earnings portion of the account is taxable income, and the account holder is required to pay state and federal taxes on only the earnings portion of the withdrawal only.
Don’t Rush; You Don’t Have a Time Limit
If your child decides not to go to college, don’t panic or rush in your decision about what to do with the 529 plan. Unlike other educational savings accounts, the 529 College Savings Plan does not expire or have a time limit. You can even save the funds for your grandchild.
Also, it’s important to remember that your child may not go to college right away, but after a few years at a 9-5 may have a change of heart. If you think that your child might decide to go to college, set a date three to five years in the future to discuss what to do with the account. On the other hand,if you’re confident that your child isn’t going to college, don’t drain the funds immediately. The account could serve as an Emergency Fund to withdraw from as necessary down the road.
Before making a final choice about what to do with the account, take some time to process your options and talk to your tax professional. If you live in a state without tax and can avoid the 10% penalty, withdrawing the funds may be a worthwhile option.
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