529 Plans: Archvest Knowledge Base

Is it time to start saving for college? 529 Plans are one of the most popular investment tools for college savings, but how flexible is the plan? Would if your child decides not to go to college or gets a scholarship? Watch this video to learn more about the options and flexibility a 529 Plan can offer.

It's every parent's dream: your child gets a gigantic scholarship to college and you've got thousands of dollars leftover in your college savings account. What to do?

Leftover money may not be an everyday occurrence, but it's possible for parents who:

  • Have well-funded accounts.
  • Have children that receive large scholarships.
  • Have children that decide not to attend college.

"Fortunately, there are a number of ways for these funds to be used or repurposed," says Taryn McCarthy, senior product manager at The Hartford Financial Services Group in Hartford, Conn.

Here are some of the options:

  1. Transfer the funds to another beneficiary.
    The most common solution to the leftover money problem is to transfer the funds to another beneficiary, such as a sibling, the original beneficiary, a cousin or even a parent. "When we talk to our clients who have excess funds because of a scholarship, the most common desire is to pass it on to a sibling, cousin or even themselves," says Jeff Paladini, CFP and managing director of investments and insurance at Karsten Tax & Financial Management in Fort Worth, Texas. Parents can use the money to fulfill some of their own dreams and ambitions for continuing education once their children leave the nest, he says. As long as the continuing education is a qualified expense, which many courses are, those funds can be used for that purpose. Most 529 plans allow you to change beneficiaries once a year. You could decide to immediately transfer the money to another beneficiary or leave it in that child's name for a few more years. You could also change your mind again later and transfer it again.
  2. Save the funds for future educational needs for that child.
    "Even if the child decides not to go to college, don't rule out technical school or even college down the road," says McCarthy. "Your son or daughter could change his or her mind and decide to go back to school." A child who earns a large scholarship may be a candidate for graduate school, a place where you can certainly use excess 529 funds left over from college. Even if your child decides not to go to graduate school right away, you can leave the money in that 529 account for future educational needs, if that's a possibility.
  3. Use the funds for future generations.
    Many financial planners view 529 plan funds as an important estate-planning tool. Even if you don't have any grandchildren yet, you could transfer the funds to yourself and then transfer the money to a grandchild or grandchildren, once they are born and have a social security number. "529 plans allow you to leave an educational legacy for your kids and their kids," says Paladini. "There's never been a benefit like this where you're able to pass on funds for education to future generations." If you're wealthy and either you or your children can afford to pay for the children's college without tapping their 529 plan funds, those funds can grow for years and benefit future generations. Compounding is very powerful when it applies to funds that sit in a 529 plan account for 20 years or more. Your heirs could then pass those funds on themselves.
  4. Take advantage of penalty-free scholarship withdrawals.
    If your child qualifies for a tax-free scholarship that falls under Section 117 of the IRS Code, or educational benefits under the GI Bill, you can withdraw the same amount of money as the scholarship or benefits from your 529 plan tax free. You'll still have to pay tax on any gains, says McCarthy, but you will avoid the 10 percent penalty that usually is assessed on non-qualified withdrawals from Section 529 plans. If you have a loss on your investments within the 529 plan, you won't pay any tax on the gains.
  5. Use the money for non-qualified expenses.
    Should you decide to remove funds from your 529 plan for non-qualified expenses, you'll pay a 10 percent penalty plus income tax on any gains earned on your 529 plan investments. That's the least desirable option, but sometimes it's necessary. If your investments in your 529 plan have lost money and are at a level below what you initially invested, you won't have any gains, so you won't be subject to capital gains tax. Also, the 10 percent penalty only applies to earnings on 529 plan investments, so if you have lost money on your investments, that penalty won't apply because your withdrawal will be considered as a non-taxed and non-penalized return of contributions. In the unfortunate instance that your child becomes disabled before he or she is able to attend college or dies, you are exempt from the penalty, but not from the 10 percent tax on any earnings, says Paladini.

John Wenzel | Archvest Wealth Advisors

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