7 tax-savvy ways to get the most out of your 529 plan

A 529 plan is a great way to save for your children's education, but what happens if they don't use the funds for education-related expenses or don’t want to go to college at all? The good news is that you have more options than you think.

From changing the beneficiary to transferring the funds, there are ways to adapt the plan to your needs. Let's explore what a 529 plan is, what happens if you don’t use your 529 plan immediately after high school, how to avoid penalties and tax mistakes, and how to best use the funds if a beneficiary is changed later.

Unused 529 funds may be more common than your family expects. For students who attend college, scholarships and grants may cover some of the costs, reducing how much additional aid is needed. A student also may choose a more affordable college (for example, community college instead of an out-of-state university) or opt for living at home instead of paying for dorm housing.

Funds also may remain if a student graduates early or chooses a major with a less demanding course load. And if a student decides not to attend college, pursues a trade or certification program with lower costs, or takes a gap year, that also can change the education timeline and funding needs.

If the beneficiary of the 529 plan ends up not needing the funds, whether due to scholarships or simply a change in educational plans, there still are options to access the money. While 529 plans restrict how funds can be used, federal law offers options for penalty-free withdrawals. Just keep in mind that state tax laws vary, so it’s important to understand how your state handles distributions before making any moves.

Here are seven options for unused 529 plan money:

Beneficiaries of 529 plans now are able to make penalty- and tax-free rollovers into a Roth IRA, given certain criteria are met.

Criteria:

• The 529 beneficiary must be the IRA owner and will have to have earned income.
• Rollovers will be subject to the annual Roth IRA limits in the year they are rolled, less any contributions you've previously made for the year (e.g., limits are $7,500 in 2026 under age 50; age 50 or older can add an additional $1,100 catch-up contribution in 2026).
• The 529 plan must be at least 15 years old.
• Any contributions or earnings from the past five years are not eligible to be rolled into the Roth IRA.
• The lifetime maximum of funds rolled over is $35,000.

Federal tax code allows 529 account holders to change the beneficiary to a different family member.

Permissible family members include the original beneficiaries:
●      Spouse
●      Child
●      Grandchild
●      Sibling or stepsibling
●      Parent or stepparent
●      Nephew or niece
●      Aunt or uncle
●      First cousin
The spouse of any of these relatives may qualify as well.

Another way to avoid federal taxes and penalties on leftover 529 money is by repaying up to $10,000 in student loans for the designated beneficiary or their siblings, including stepsiblings. This $10,000 limit is per person, not per account. If your designated beneficiary has two older siblings who graduated with student loan debt, a plan could put $10,000 toward each of their loans.

Since you can change a 529 plan's designated beneficiary, it's even possible to make yourself the beneficiary and use up to $10,000 in plan distributions to repay your own student loans. Be aware, however, that student loan interest repaid from a 529 plan distribution isn't eligible for a federal tax deduction.

With “bridge-year” programs becoming popular in the ‘80s, gap years gaining momentum in the early 2000s and the recent COVID-19 pandemic often forcing wait times between high school and college, students don’t always move straight from a high school graduation to a college campus. One advantage of a 529 plan is that there is no time limit.

There’s no need to rush or worry if the 529 funds aren’t used right away. The account can remain invested and continue to grow tax-advantaged for years. This makes it a useful option for students who need more time to decide where they want to attend undergrad or graduate school, or which professional programs to pursue.

Considering the costs of graduate programs, law school, medical school and specialized certifications, choosing the right place and the right time to attend helps. Having funds already set aside also can reduce the need for student loans.

In addition to having more flexible education plans, many people also are becoming parents later in life. That extra time can create opportunities for grandparents to help fund a grandchild’s college education through a 529 plan.

Account holders can change the beneficiary of their 529 plan to another qualifying family member, including a grandchild, without triggering taxes or withdrawal penalties. Since there’s no time limit on when the funds must be used, your account can remain invested for many years while continuing to grow tax-advantaged.

A 529 plan also can offer estate-planning benefits. Contributions are considered “completed gifts” for tax purposes, but you still can change beneficiaries while deciding when withdrawals are made. This multi-generational strategy allows the account to continue compounding and creates a long-term education legacy while supporting broader estate-planning goals.

Students who receive scholarships may qualify for the 529 exception. This means you can withdraw an equal amount from the 529 plan without paying the usual 10% penalty on non-qualified withdrawals. The earnings portion of the withdrawal still may be subject to ordinary income tax, but the original contributions aren’t taxed since they were made with after-tax dollars.

This exception also may apply to other forms of tax-free educational assistance, such as grants, employer education benefits or veterans’ educational benefits. You should keep documentation of the scholarship award details for tax purposes and to avoid risking a 529 withdrawal penalty.

What 529 plan alternatives are there if you don’t use the funds for any educational purpose at all? The good news is you don’t have to forfeit the savings or be stuck with unused funds you can't touch. You can withdraw these funds, but be aware that taxes and penalties may apply.

On your federal tax return, you’d treat the earnings portion of the withdrawal as ordinary income and typically owe a 10% penalty on the investment returns your contributions generated. In other words, you'd essentially lose the tax-deferred growth benefit the account provided.

This penalty may not apply, however, if you take a distribution because your beneficiary:

●      Earned a scholarship or grant.
●      Enrolled in a military academy.
●      Became disabled or died.
●      Received funds from an employer for their educational expenses.

In cases like these, you may not have to pay penalties, though state taxes still could apply if you previously received a state tax deduction when contributing to the account.

If your beneficiary is in a lower tax bracket than you, you also may be able to reduce taxes and penalties by paying the withdrawn amount directly to them. Another option is to wait until you're in a lower tax bracket yourself to withdraw, such as after a layoff or retirement.

No, although 529 plans are commonly used to save for college, funds don’t have to go toward a traditional four-year university. The law allows you to put the money toward any "eligible postsecondary school," which has a broader definition. The only true restrictions are that the school must be accredited and eligible to participate in the federal student aid program.

While the following options may not apply in every state and always should be verified, here are some common alternatives for 529 funds:
●      K-12 tuition expenses, up to a $10,000 limit.
●      Vocational schools.
●      International schools.
●      Apprenticeship programs registered with the U.S. Department of Labor.
●      Wilderness first aid course or the Outward Bound program.

Tuition, school fees, books, supplies, and room-and-board costs are generally safe ways for you to use 529 funds at eligible educational institutions. It’s still a good idea to check your state’s rules before using 529 plan funds.

If money is withdrawn from a 529 plan for expenses that aren’t considered qualified education costs, you may face a penalty and owe ordinary income taxes. Typically, this means a 10% federal penalty on the earnings portion of the withdrawal.

The 10% federal penalty only applies to the investment earnings in the 529 plan account, not to the original contributions, since those were made with after-tax dollars. The contributions, or principal, are the funds you originally deposited. The earnings, or growth, are a combination of interest, dividends or investment gains.

For example, let’s say you contributed $8,000 to a 529 plan with earnings of $4,000. If you withdrew the full $12,000 for non-qualified expenses, the first $8,000 would not be subject to ordinary income taxes or the penalty. The remaining $4,000 would be subject to both.

Keep in mind that there may be exceptions where the IRS penalty may be waived. This can happen if the student receives a scholarship, enrolls in a military academy, becomes disabled or dies.

Unlike other savings methods, such as traditional IRA, 401(k) or 403(b), you don't have to withdraw money from a 529 plan by a certain date. With no deadline withdrawal rules, you can take your time and consider all your options.

If you don't need the unused balance for a near-term purpose, you can leave it untouched in case a relative needs it for graduate school or your spouse decides to pursue an MBA. You can continue investing in your 529 for years, preserving the account's tax benefits.

Saving money in a 529 plan takes dedication, and making the most of it takes a strategy. Consider connecting with a Thrivent financial advisor to review your options if you find yourself with an unused 529 plan and you're unsure of the best way to proceed.