What to Do When You Overfund Your 529 Plan

What to Do When You Overfund Your 529 Plan
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Fall is when millions of students fill out college applications while their parents tackle the Free Application for Federal Student Aid and start seriously looking at tuition costs at universities. College costs have risen an astounding 1,200% over the last few decades, so it’s no wonder an increasing number of families (over 15.33 million) are saving for their loved one’s education in a tax-advantaged 529 account.


It’s easy to see why 529 plans are so popular. Account distributions and earnings are not taxed if they are used for qualified educational expenses. While contributions are not tax deductible for federal purposes, some states offer significant tax deductions. Additionally, 529s are considered the parent’s asset rather than the student’s when financial aid is calculated.


[RELATED: Education Assistance From MOAA]


But there are also restrictions on who can use the money and what constitutes a qualified education expense. A student may decide to enter the military, drop out of college, use GI Bill benefits, or receive a full scholarship. All this can lead to a situation where a plan is “overfunded,” meaning there is money left over in the account.


Having too much in your college savings account may sound like a good problem to have, but withdrawing that extra money can be costly. If you use the funds for anything other than a qualified education expense, you will pay a penalty plus income tax on any of the gains. Here are some options families can consider if they have overfunded a 529 account.


Save It for Later

Just because your child doesn’t want to go to college now doesn’t mean they won’t sometime in the future. 529 funds can be left in the plan indefinitely, so there’s no rush to use them right away. They can also be used for future costs beyond undergraduate tuition, such as graduate school, apprenticeships, and other qualified expenses like textbooks, living expenses, computers and other supplies, and internet access. The 529 funds can even be used for K-12 expenses and continuing education courses.


Give It to Someone Else

Since there’s no requirement to distribute the funds, they can remain in the plan and be passed down to a sibling or other qualifying family member – parents, aunts, uncles, nieces, nephews, stepparents, even first cousins. If no one in the immediate family is a good candidate, you can leave them to an unborn child or grandchild, although you’ll have to make yourself the beneficiary until they have a Social Security number assigned.


Offset Scholarships or GI Bill Benefits

If the beneficiary gets a scholarship, uses their GI Bill benefits, enlists in the military, or enrolls in a service academy, they can withdraw funds from their 529 without paying the 10% penalty. However, they still must pay income taxes on any earnings.


[RELATED: How to Figure Out Your GI Bill Strategy]


Pay Off Student Loans

A provision of the SECURE Act allows 529 funds to be used to pay off student loans. There’s a lifetime limit of $10,000 in payments per beneficiary, though, and you cannot take the student loan interest tax deduction on your income taxes for the portion that is being paid for by tax-free 529 funds.


Take the Money – and the Penalties

If you really think there is no chance you or anyone else in your family will ever use the funds in the 529 plan for education-related purposes, then go ahead and take a nonqualified distribution. But you will pay a 10% penalty plus income tax on any of the earnings your fund had over the years.


A 529 plan remains a great and flexible way to save for education. However, it’s a good idea to have a plan in place for any excess funds that might be left when the initial beneficiary is finished with their schooling.


Did You Know?

The MOAA Scholarship Fund provides interest-free loans and scholarships to children of military families: $8.5 million of educational assistance was provided in the 2021-2022 school year, including a record $2.6 million in grants for over 1,100 students.

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About the Author

Lila Quintiliani, ChFC®, AFC®
Lila Quintiliani, ChFC®, AFC®

Quintiliani is MOAA's Program Director, Financial and Benefits Education/Counseling. She is a former Army Military Intelligence Officer as well as the spouse of an active-duty servicemember, and worked for over a decade at military installations as a personal financial counselor.