Many parents save for their child’s college education using a 529 account. But what happens if you “over-fund” the account and save too much?
If you are lucky enough to have this problem, you have three options:
- Reassign: You can reassign the 529 account to a direct relative without any tax consequences. This includes nieces, nephews, cousins, aunts, uncles, or even yourself, for future education goals.
- Withdraw It (and Pay the Penalty): If you withdraw the money for non-educational purposes, you’ll pay state and federal income tax on the gain, as well as a 10% penalty (+ a 2.5% if you live in California). Non-qualified distributions payable to the beneficiary (the child) are taxed at the beneficiary’s tax rate. Non-qualified distributions payable to the parent are taxed at the parent’s ordinary income rate.
- Save It: By not withdrawing the money, you allow the investments to grow tax free. You can then withdraw the money in a lower-income year. Alternatively, the money can be left alone for the child’s graduate school or a future grandchild’s education costs.
The takeaway is that there isn’t a penalty for leaving extra money in a 529 plan after a student graduates.
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