What to Do with Surplus 529 College Savings

Here's a problem most people would love to have: they saved TOO MUCH for their child's college education (because the daughter got an unexpected scholarship.) So, how do you deal with this? Is the money stuck in the account or will the parent be forced to take a big penalty when she withdraws it? Well, there is a good option:

Typically, the earnings portion of outright withdrawals not used for education expenses is taxed as income and subject to a 10% penalty as well. Some states would also want to recapture the taxes that would have been paid on the deducted contributions. But if Fox changes the beneficiary to one of Katie's sisters, there is no tax or penalty on the transfer because the new beneficiary is a member of the previous beneficiary's family. (The family tie must be between beneficiaries, not the account holder and the new beneficiary.)

We have a 529 for each of our kids and this strategy could be part of our plan. If our son doesn't need all of his money, we could shift it to our daughter. Likewise, if she doesn't need all of her savings, we could shift it to him. That's a long way off at this point, but it's certainly something that I've considered.

So, what would we do if we had more money than both kids needed? I think we'd simply thank God and worry about the penalties we'd have to pay later. ;-)

For more thoughts on saving on and for college, see Best of Free Money Finance: College and Education Posts.

Comments

[Lee]

I have saved enough for my son's education and plan to leave the extra in his 529 account for him use for his children. Since he is an only child there is no one else to give this money to and by saving it for his children that makes one less expense for him once he is raising a family.

[Blaine Moore (First Time Home Owner)]

Yeah, that's one way to go about it. Also, could you transfer it to yourself and take some continuing education with it as a further option?

[Mark]

I thought that a 529 beneficiary could actually withdraw an amount equal to the scholarship they received? This would moot the issue.

[Al]

Mark's correct. When the benficiary receives a scholarship, an amount equal to the amount of the scholarship can be withdrawn, and the earnings would not be subject to the 10% penalty but would be taxed as ordinary income. Depending on the state, the withdrawal can be returned to the owner (e.g., Virginia) or might have to be given to the designated beneficiary (e.g., Arizona).

If I were providing advice to the person asking the question originally, I would suggest she hold off cashing in the 529 plan until after her child graduates, in case the scholarship falls through (due to grades, etc.) or if the child wants to go to graduate school.