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What Can You Do if You Overfund a 529?

The prospect of a scholarship, grant or gift may have some parents wondering how much is too much when it comes to funding a 529 college savings account.

“An overfunded 529 is a common concern but actually not that common an occurrence,” says Robert Aruldoss, a senior financial planning analyst at the Schwab Center for Financial Research. “Finding that college costs more—not less—than expected is a much likelier scenario.”

Be that as it may, there are several options for oversavers—no matter the reason.

  • Save it for later: Once the beneficiary has earned an undergraduate degree, the remaining funds can be used at any point in the future for graduate, trade or vocational education.
  • Change the beneficiary: You can reassign a 529 to any direct relative, meaning not just offspring but also nephews, nieces, cousins, aunts and uncles—even yourself.
  • Pay the penalty: You can use 529 funds for noneducational purposes, but you’ll have to pay a 10% penalty and federal income tax on at least a portion of the withdrawal (not to mention state taxes if you benefited from a state tax credit or deduction). Why just a portion? Because only gains are taxable. For example, if a 529 account’s overall holdings are 75% contributions and 25% gains, then 25% of any nonqualified withdrawal is taxable:
     
Nonqualified withdrawal: $20,000
Percentage gains: 25% ($5,000)
Taxes: $1,250*

10% penalty:

$500
Total taxes: $1,750


That said, there are exceptions to the 10% penalty. If a student secures an employer-sponsored education benefit, tax-free scholarship, or certain other awards or grants, for instance, the 529 account holder is permitted to withdraw an equivalent amount without penalty, though ordinary income taxes will still apply.

“The important thing is to save away, secure in the knowledge you’ve got options if you happen to overdo it,” says Robert.

*Assumes a federal income tax rate of 25%, no state income tax liability, and no state tax credit or deduction on contributions.

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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investors should consider, before investing, whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available in such state's qualified tuition program.

(0819-9CEH)

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