Article updated December 2024.
Years ago, you wisely set aside money in a 529 plan to help cover a child’s future education expenses. A great decision! But what happens if your child decides not to pursue higher education or earns a full-ride scholarship and no longer needs the funds? You might consider donating the unused funds to a college or charity, perhaps your alma mater.
You Can’t Donate a 529 Plan Directly
Under current IRS rules, 529 plans cannot be directly donated to educational institutions or charitable organizations. Section 529 requires that any new beneficiary be a qualified family member of the original beneficiary, and there is no exception for charities or colleges. If you attempt to transfer a 529 plan to a non-qualifying entity, the IRS will treat your donation as a non-qualified distribution. The result? You, as the account owner, would owe income tax on the earnings portion of the withdrawal, along with a 10 percent penalty.
529 plans, also called Qualified Tuition Programs (QTPs), are specifically designed to cover education-related expenses, including:
- Tuition, fees, books, and supplies for college or vocational school
- K-12 tuition (up to $10,000 per year)
- Certain apprenticeship programs
- Student loan repayments (up to a $10,000 lifetime limit)
Although 529 plan contributions are not federally tax-deductible, the earnings grow tax-free, and distributions are also tax-free when used for qualified education expenses.
Alternative Options for Unused 529 Funds
If direct donation isn’t an option, here are some ways you can repurpose unused 529 funds:
- Rollover to a Roth IRA: The SECURE Act 2.0 introduced a new option to rollover up to $35,000 of unused 529 funds into a Roth IRA for the beneficiary, an excellent way to shift unused education savings into retirement savings for the beneficiary. The transfer is tax-free and penalty-free, but comes with restrictions, including:
- The 529 plan must have been open for at least 15 years.
- Contributions made in the past 5 years (and their earnings) are not eligible for rollover.
- Annual Roth IRA contribution limits still apply.
- Withdraw funds for non-qualified uses: If you decide to withdraw the funds for purposes other than qualified educational expenses, the principal (your contributions) is not subject to taxes or penalties. However, the earnings portion will be taxed as income and incur a 10 percent penalty.
- Leverage expanded FAFSA rules: Changes under the FAFSA Simplification Act in 2024 removed a significant barrier for families contributing to education. Withdrawals from 529 plans owned by contributors who are relatives or friends no longer count as income for the student when determining financial aid eligibility.
State-Specific Benefits
529 plans are administered at the state level, and individual states offer additional incentives. Understanding the rules in the state that administers your plan will help you maximize your plan’s benefits. For example:
- Florida: Offers both a Prepaid Plan and a Savings Plan. While Florida has no state income tax, earnings grow tax-free, and funds can be used at schools nationwide.
- New York: Allows a state tax deduction of up to $5,000 for individual filers ($10,000 for joint filers) on 529 contributions. Funds can also cover K-12 tuition but may trigger recapture of tax benefits for non-qualified withdrawals.
- Ohio: Provides a state tax deduction of up to $4,000 per beneficiary per year, with flexibility to cover expenses like $10,000 in student loan repayments.
- Pennsylvania: Offers one of the highest state tax deduction limits: $18,000 per beneficiary annually ($36,000 for joint filers). Both a Guaranteed Savings Plan (locks in today’s tuition rates) and an Investment Plan are available.
You don’t have to be a resident of a state to use that state’s plan. Each state has unique rules, so reviewing your state’s benefits is crucial to maximizing savings.
Deciding How to Use Your Unused 529 Funds
While you can’t donate a 529 plan directly, alternatives like Roth IRA rollovers, non-qualified withdrawals, or reallocating the funds to another family member provide flexibility. If you’re committed to charitable giving, you can withdraw the funds, pay any taxes and penalties, and then donate the remaining amount. In some cases, this donation may qualify for a tax deduction.
When dealing with unused 529 funds, the key is to evaluate your options and create a strategy that aligns with your financial goals. If you want help navigating 529 plans and maximizing their benefits, contact an HBKS wealth advisor to discuss your options and build a plan that works for you.
IMPORTANT DISCLOSURES
The information included in this document is for general, informational purposes only. It does not contain any investment advice and does not address any individual facts and circumstances. As such, it cannot be relied on as providing any investment advice. If you would like investment advice regarding your specific facts and circumstances, please contact a qualified financial advisor.
Any investment involves some degree of risk, and different types of investments involve varying degrees of risk, including loss of principal. It should not be assumed that the future performance of any specific investment, strategy or allocation (including those recommended by HBKS® Wealth Advisors) will be profitable or equal the corresponding indicated or intended results or performance level(s). Past performance of any security, indices, strategy or allocation may not be indicative of future results.
The historical and current information as to rules, laws, guidelines or benefits contained in this document is a summary of information obtained from or prepared by other sources. It has not been independently verified, but was obtained from sources believed to be reliable. HBKS® Wealth Advisors does not guarantee the accuracy of this information and does not assume liability for any errors in information obtained from or prepared by these other sources.
HBKS® Wealth Advisors is not a legal or accounting firm, and does not render legal, accounting or tax advice. You should contact an attorney or CPA if you wish to receive legal, accounting or tax advice.
