Have Unused Funds in a 529 Account? A New Rule Change Will Allow You to Invest It

If your goal is to save up enough money to put your kids through college, then opening a 529 plan is worth looking into. Unlike a regular brokerage account, where you pay taxes on investment gains year after year, gains in a 529 plan are yours to enjoy tax-free, as are withdrawals, provided that money is spent on qualified education expenses.

And those expenses aren't limited to college. You can take a 529 plan withdrawal to pay for private school for your fifth grader should you so choose. However, these plans are commonly referred to as college savings plans because many parents open them for that express purpose.

But there's a risk in saving in a 529 plan, and it's ending up with excess funds. Granted, it can be argued that this is a very good problem to have. But it's also a problem that could prove costly.

If you take a 529 plan withdrawal for non-education purposes, you'll be penalized 10% on the gains portion of that sum. You won't be penalized on the principal portion, though, because 529 plans are funded with after-tax dollars. Non-educational withdrawals from a 529 plan are also subject to taxes.

But beginning in 2024, the rules here are changing for the better. Starting next year, you'll have more options for putting untapped funds in a 529 to good use.

When you have an overage on your hands

Given the ever-rising cost of college, it's natural for parents to aggressively fund their 529 plans. But what if one of your children goes rogue and decides college isn't for them at all?

Suddenly, you have a balance you need to get very creative about using up to avoid penalties. And while you can always switch beneficiaries within a 529 plan, that won't necessarily solve your problem.

Say your oldest child opts out of college but you have enough money in your younger child's 529 plan to pay for their college completely. That still leaves you in a bind with regard to your older child's balance.

Beginning in 2024, however, you'll have the option to roll unused 529 plan funds into a Roth IRA for that 529's designated beneficiary. There are, however, some rules you'll need to follow.

• You can only roll whatever amount represents the annual limit for IRA contributions. This year, that limit is $6,500 for savers under 50. As that limit rises, you should expect to be able to roll a higher amount from a 529 to a Roth IRA per year.
• Those Roth IRA rollovers are subject to a lifetime limit of $35,000 per beneficiary. So if you're stuck with $60,000 in a 529 that your child doesn't want to use for education, you'll still need a plan for your remaining $25,000.
• Your 529 plan must be open for at least 15 years before you roll unused funds into a Roth IRA. And 529 plan contributions made within the past five years can't be rolled over.

A positive change

Many parents work really hard to build up nice balances in their 529 plans. If you end up with an overage on your hands, the last thing you deserve is a world of stress because of it. Starting in 2024, you have more options for putting that money to good use, which makes funding a 529 plan a less risky proposition.

That said, at some point when your kids reach their mid-teens, it's a good idea to have a conversation about college and make sure you're on the same page. You don't want to keep funding a 529 plan when your 16-year-old insists they'd rather start a business right out of high school than pursue a degree.

And also, your kids may be on board with doing two years of community college before heading to a four-year school, resulting in a lower higher education tab on a whole. So the sooner you have these discussions, the less likely you might be to end up with an overage in your 529 in the first place.