“529 Plan Overfunding – What to Do” by Les Smeach, CPA/ABV, CVA, CFF | Principal – Tax

Earlier this week Georgette Jasen of The Wall Street Journal discussed the dilemma of overfunding 529 plans. In her article, Georgette discusses the current economic environment and how most parents are concerned about not having enough money for their child’s education. Most of those same parents are using 529 plans to accumulate the funds they can afford to put away for education, but sometimes a 529 plan account can end up with more money than is needed. This can happen for several reasons, with the most common being a child decides they don’t want to go to college.

Here’s a summary of what parents can do if they accumulated more than they need

  1. Take the cash and pay tax on the earnings and a 10% penalty. This is not a wise economic move.
  2. Direct the child to go to a post-secondary vocational school or a technical training program that is eligible for federal financial aid programs.
  3. If the child completes undergrad, use the excess funds for graduate school.
  4. Change the beneficiary of the account to another family member, maybe a parent who wants to further their education or possibly consider a grandchild.
  5. What happens if the child lands a big scholarship? In this case, there is no 10% penalty on money withdrawn as long as the withdrawal amount does not exceed the scholarship. The accumulated earnings would still be taxable.
  6. Heaven forbid a beneficiary dies or becomes disabled. If one of these events occurs, the 10% penalty is waived, however the accumulated earnings would still be taxable.
  7. If you don’t need the money, leave it alone. In most plans you can leave it in the plan and let it grow tax-free indefinitely, as long as the beneficiary is alive.
  8. A final idea: if there is no future beneficiary in sight, donate the money. You might get an itemized deduction if you can itemize, and this strategy will help mitigate the tax bite and penalty.