Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / What Happens to a 529 Plan If Your Child Doesn't Go to College
Transcript
- Lucas: You know what I was rereading last week? A study from the College Savings Foundation that said roughly one in three 529 plan beneficiaries never end up using all the money for their own college education. Luna: That's a pretty high number. So what happens to all that savings? Does it just get stuck in the account? Lucas: Far from it. The 529 plan is actually more flexible than most people realize. If the intended beneficiary decides not to go to college — or goes but doesn't use all the funds — you have several options, and none of them require you to forfeit the money. Luna: Okay, let's go through them. What's the first thing someone should consider? Lucas: The easiest is changing the beneficiary to another family member. The IRS defines family pretty broadly here: siblings, parents, in-laws, aunts, uncles, first cousins, even the account owner themselves. So you could redirect the money to a child's sibling, or to yourself if you want to take a class later. Luna: Wait, you can change the beneficiary to yourself? That's interesting. So if I started a 529 for my niece, I could later switch it to my own name? Lucas: Exactly, as long as you become the new beneficiary. No penalty, no tax hit. The funds just keep growing tax-deferred for the new beneficiary. And you can do this as many times as you want, within the family definition. Luna: What about the Roth IRA rollover? That was a big change a couple of years ago. Lucas: Right, the SECURE 2.0 Act made it possible to roll over up to $35,000 from a 529 into a Roth IRA for the beneficiary. But there are some quirks — it counts towards the annual contribution limit, and the 529 has to be open for at least 15 years. And it's per beneficiary, lifetime. Luna: So if my son decides he doesn't want to go to college, he could get a $35,000 head start on retirement? That's huge. Lucas: Absolutely. But it's important to remember the 15-year clock: you can't just open a 529 and roll it over next year. And if the beneficiary already has Roth contributions, you have to coordinate. Luna: Let's say there's no other family member to switch to, and the Roth option is too small. What then? Lucas: Then you have to consider a non-qualified withdrawal. The earnings portion gets hit with income tax plus a 10 percent penalty. But the original contributions come out tax-free since they were made with after-tax money. So if you had $50,000 in the account and $10,000 was earnings, you'd pay taxes on that $10,000 plus a $1,000 penalty. Luna: Ouch. Are there any exceptions to that penalty? Lucas: Yes, several. Most common is the scholarship exception: if the beneficiary gets a full or partial scholarship, you can withdraw an amount equal to the scholarship without paying the 10 percent penalty. You still pay income tax on the earnings, but no penalty. There's also an exception if the beneficiary attends a U.S. military academy. Luna: So scholarship students aren't totally out of luck. What if they decide to go to a trade school instead of a four-year college? Lucas: That's still a qualifying expense. Trade schools, vocational programs, apprenticeships are all eligible. So many times the 'didn't go to college' story is really 'didn't go to a traditional college.' The 529 can cover tuition, fees, books, tools for programs like welding or cosmetology. Luna: I've seen a trend of families pausing their 529 contributions because they're worried about overfunding. But it sounds like you're saying that's not really a big risk. Lucas: For most families, it's not. If you're saving aggressively and your child gets a full ride, you've got all these options. And you can change the beneficiary to a grandchild, a niece, or even a future spouse. The only real risk is if you need the money for something else quickly and don't want to deal with the penalty. Luna: Right. Speaking of flexibility, I want to bring up something that happened to a friend. She had a 529 for her daughter, who decided to join the military. She was worried the money would be locked. But she found out she could change the beneficiary to her son, who was planning on college. Lucas: That's a perfect example. And the daughter could still use the funds later if she wants to attend college after service — military tuition assistance doesn't eliminate the need for a 529. You can keep the beneficiary as the daughter and just let the money sit. Luna: So the 529 really isn't an all-or-nothing plan. It's more like a savings vehicle with multiple exit ramps. And I think a lot of listeners don't realize that. Lucas: That's exactly why we're talking about this. The more you understand the options, the less scary it feels to save. And if today's conversation helped you think about your own plan differently, honestly, that's what keeps us doing this show ad-free. Luna: Yeah, if this was worth a coffee to you, we'd appreciate the support at buy me a coffee dot com slash fexingo. It's the smallest ask, but it lets us keep these episodes focused on what matters. Lucas: Exactly. Just a few bucks helps cover our hosting and research. No pressure. Now back to the topic — you know, there's another development I find interesting. Several states are now allowing 529 funds to be used for certain credentialing programs, like coding bootcamps. Luna: Wait, coding bootcamps? Those aren't typically considered colleges. How does that work? Lucas: It's a state-by-state thing, but more states are expanding the definition of an eligible institution to include non-college programs that lead to a certificate or license. For example, New York and Arizona have passed laws that treat skills-based programs as qualified institutions. So you could use a 529 to pay for a cybersecurity bootcamp. Luna: That's huge. So the 529 is evolving from just a college savings account to a lifelong learning account? Lucas: Exactly. And I think that trend will continue. The more portable and flexible 529 plans become, the more they make sense for anyone who expects to have some education expenses in the future. Luna: So what's the one takeaway you want listeners to remember? Lucas: Don't be afraid to start or continue funding a 529 just because you're not sure what your child will do. You have options: change the beneficiary, roll to a Roth, use it for trade school, or even take a penalty with taxes if you really need the cash. And the rules keep getting more generous. Luna: That's reassuring. I think a lot of parents stress about overfunding, but these options really do cover most scenarios. Lucas: They do. And as always, check your state's specific rules, because some offer added benefits or have different definitions. But the federal framework gives you a lot of room to adjust. Luna: Great stuff, Lucas. Until next time. Lucas: Take care.