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What to Do With a 529 Plan If Your Kid Doesn't Go to College

Donna Rosato

Consumer Reports has no financial relationship with advertisers on this site.

Consumer Reports has no financial relationship with advertisers on this site.

You’ve been saving for years in a 529 plan, which lets you fund your child's college costs tax-free. But what happens if your kid doesn’t go to college? Will you face a steep tax bill? 

Not to worry. Money in a 529 account can be used tax-free for many types of schooling, not just expenses at a four-year college. And there are several ways you can use those savings, even if your child doesn’t pursue any type of higher education—in fact, the recent tax overhaul added a few new options (more on that below).

There's also no time limit on using the funds. “A 529 never expires,” says Mark Kantrowitz, publisher and vice president of research at Savingforcollege.com, a website the provides information on 529s and allows you to compare state-sponsored plans. That gives you leeway to decide how to use the money if your child is on a different track.

Saving in a 529 remains one of the best ways to save for college because you get big tax breaks on the earnings if you spend the money on qualified education costs. More than 30 states also give you a tax deduction on your contributions.

The tax benefits, along with the rising cost of college, are encouraging more families to save in these plans. The number of 529 accounts hit a record 13.3 million in 2017 and assets totaled $319 billion, double the amount in 2010, according to the College Savings Plans Network, a coalition of state-run 529 plans.  

Still, “most families aren’t saving enough for college or saving at all,” Kantrowitz says. More than 40 percent of parents aren't putting away money for college, according to a survey by Sallie Mae, which provides student loans. Just 18 percent of children under 18 have a 529 plan, and the average balance is $24,000, a fraction of the cost of public or private universities.

It's easy to get started, even if you don’t have a lot to put away. In most states, you can open a 529 with just $25. A few states—Utah, for one—have 529 plans with no minimum contribution.

Just having an account, even if it's small, can be a powerful motivator to attend college and graduate. Even a child with less than $500 in any type of college savings account before reaching college age is three times more likely to enroll in college than a child with none and four times more likely to earn a degree, according to a 2017 report by the Institute of Higher Education Policy and the Corporation for Enterprise Development.

Recognizing the benefits, a number of states and cities are trying to encourage families to save for college with 529s. In San Francisco, Nevada, and Maine, for example, children entering kindergarten are automatically enrolled in a college savings fund. Some states offer incentives or small matching grants for people who open 529 accounts. 

Even if Junior doesn’t take a traditional college path, saving in a 529 can be a smart move. Here’s why.

529s Aren't Just for Four-Year Colleges

You can use money in a 529 at any institution of higher education that receives financial aid. That includes community colleges; technical, art, or music schools; vocational and certificate programs; trade schools; and continuing education courses. You can look up qualifying schools and programs here.

The money can also be applied to costs for study-abroad programs. There are about 400 colleges in other countries that are eligible to use 529 money, Kantrowitz says.  

The only caveat is that you must spend 529 savings on qualified expenses. That includes tuition, fees, books, supplies, and computers, as well as room and board for students in school at least half-time. But it won’t cover costs like college application fees, personal living expenses, or transportation. 

Family Members Can Use the Money

Most 529s plans allow you to change the beneficiary once a year. So if your child won't be using the money, you can transfer the assets penalty-free to eligible family members, such as the account owner (typically a parent or grandparent) or a close family member.

The list of eligible family members is extensive—it could be a sibling, aunt, uncle, niece or nephew, step-sibling, parent, step-parent, spouses of all those individuals, or a first cousin.

What if your child has a change of heart? You can always convert the 529 account back to the original beneficiary.  

You Can Pay Some Special-Needs Costs

If your child has a documented physical or emotional disability, you can tap a 529 to pay for some types of support. The money can cover services that enable your child to attend a post-secondary school. If the disability prevents the student from attending school, you can withdraw the money without penalty, though you would still pay income taxes on the earnings.

Under the new provisions of the Tax Cuts and Jobs Act, which became law last December, you can also roll over assets from a 529 plan to an ABLE (Achieving a Better Life Experience) account—a savings vehicle for people with disabilities—without any penalty. But the ABLE account and 529 account must be for the same beneficiary or another member of your family who has special needs.

K-12 Private School Costs May Be Eligible

For those with kids attending nonpublic elementary or secondary schools, the new tax law gives you another option for 529 money. You can withdraw up to $10,000 without paying federal income taxes to cover tuition at private or religious elementary and secondary schools.

But unless you have additional savings tucked away, be cautious about using 529 money before your child reaches college, says Jim DiUlio, chairman of the College Savings Plan Network. “You should still be saving for higher education needs, too,” he says.

Cashing Out May Not Incur a Big Tax Bill

If all else fails, you can just withdraw the money—and that move may not cost you as much in taxes as you might think. The withdrawal amount will be taxed at the beneficiary’s rate, which is likely to be lower if it’s your child. You’ll pay a 10 percent penalty, but it’s just on earnings growth, not the whole value of the account.

There are a few situations where you may not incur a penalty at all. If the beneficiary dies or becomes disabled or if he or she goes to a U.S. military academy, no penalty applies. And if your child gets a scholarship, you can withdraw up to the amount of the award and spend it on whatever you want. But you’ll pay income tax on any gains in the account when you make withdrawals.



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