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When saving for your kids’ future college expenses, there’s nothing better than a 529 Plan. These accounts allow you to save and invest while receiving tax-free withdrawals if used to pay for certain education expenses.

But parents can be hesitant to commit to an account with a narrow restriction on how the funds can be used. After all, the future is uncertain.

What if my kids don’t go to college?

What if they get a full ride scholarship?

What if I have an emergency and need that money?

First, we’ll cover the basics of how 529 Plans are designed. Then, we’ll look at the consequences of using 529 funds for other expenses. Finally, we’ll explore options if you want to change course with your 529 Plan.

Basics of 529 Plans

529 Plans are still owned by the parent.

First, it’s appropriate to remember that a 529 Plan is owned by the parent. While you name one of your kids to beneficiary (the one whose future college expenses you are planning to pay), you don’t give up control of the money.

This means that you always reserve the right to use the money how you want. You can withdraw the funds at any time. Yes, there are tax consequences, but it still is your money.

Contrast this with an UTMA custodial account. Money you put into an UTMA account is an irrevocable gift to your child, and you are restricted from “taking back” the money if plans change.

With a 529 Plan, you still reserve the flexibility to change course since you’ve maintained control of the account.

The IRS has a list of what you can use 529 funds for.

The IRS calls these “qualified education expenses” and are meant to support the enrollment and attendance at a post-secondary institution (click here to see if your institution is 529 eligible).

The big expenses that everyone is concerned about—tuition, books, room and board—are all qualified.

In addition, the Tax Cuts and Jobs Act of 2017 allows families to use $10,000 per year for tuition at an elementary or secondary school.

Withdrawals not used for education

You might owe taxes and penalties on the earnings.

However, withdrawals that aren’t used to pay for “qualified educational expenses” would have tax consequences. Namely, you will have to count the earnings as income on your taxes, and you will owe a 10% penalty on those earnings.

Let’s say you contributed $20,000 to a 529 Plan. Over time, the balance grows to $30,000. If you withdrew the full $30,000 to pay for a kitchen remodel, here’s what it could look like:

$20,000 – return of contributions (tax-free)

$10,000 – earnings (include this as ordinary income on your taxes)

10% penalty on the $10,000 – $1,000 penalty

If someone was in the 22% federal tax bracket, that could be $2,200 of income tax ($10,000 x 22%) plus $1,000 penalty = $3,200.

Even if you withdrew a smaller amount—say $20,000, you have to treat those dollars as a mix of your contributions and earnings (pro-rata).

Additional considerations for Arizona residents.

If you live in a state that gave you a state income tax deduction for your past 529 contributions, you also must pay back those past deductions if you end up making non-qualified withdrawals. Since the deduction is currently not large (capped out at $2,000/$4,000 for single/married tax filers in Arizona), this should be a much smaller amount than the aforementioned federal taxes and penalties.

Bottom line—a 529 Plan is not meant for kitchen remodels, and these types of withdrawals would be a more expensive route. But it’s also not the end of the world if plans change.

How to avoid taxes and penalties

Fortunately, 529 Plans do offer some flexibility if plans change.

Avoid the penalty if your child gets a scholarship.

If your child gets a scholarship and you have unused funds in his/her 529 Plan, you can withdraw up to the amount of the scholarship penalty-free. You will still pay income tax on the earnings, but this allows you to avoid that additional 10% penalty.

Change the beneficiary to another family member.

An overlooked way to keep unused dollars in a 529 Plan is to change the beneficiary. Remember, you are the owner of the 529. At any time, you can change the beneficiary. This can be another child, a grandchild, or even yourself or your spouse.

Rollover the 529 Plan to your child’s Roth IRA.

Starting in 2024, you can take unused 529 money to fund your child’s Roth IRA. There are certain details to make sure you do this correctly:

There is a lifetime limit of $35,000.

The Roth IRA must be in the name of the 529 Plan beneficiary.

The 529 Plan must have been opened for 15 years.

Contributions made in the previous five years are ineligible for rollover.

Rollovers are capped by the annual contribution limit (cannot do the entire $35,000 at once).

Is a 529 Plan right for me?

As we wrote in this article, there are multiple ways to save for your kids or grandkids. Just like most things, the answer has to do with what you value most. Flexibility? Tax savings? Estate planning?

For me and my clients, a simple way I help answer this question is identifying the primary goal of your savings:

College saving: 529 Plan

Future big expenses (wedding, house): UTMA or your own taxable account

Gifts: UTMA

If you decide to incorporate 529’s into your financial plan, hopefully this blog helps you know the pros, cons, and flexibility that these accounts offer.