An Embarrassment of Riches: What to Do with an Overfunded 529 Account

Hollywood icon Mae West is reported to have said, “Too much of a good thing is wonderful!” While most of us would have a hard time thinking of a situation where too much money in savings would ever be a problem, there can be complications when a 529 education plan has more funds than are needed for handling the educational expenses for which it was intended. Because withdrawals from a 529 education plan are subject to a 10% penalty—plus ordinary income taxes—unless they are used to pay for qualified educational expenses, what do you do with the funds if the beneficiary has graduated or otherwise has no more need for them?

Roll over to a Roth IRA.

Fortunately, there are several alternatives that don’t require taking a tax hit. One that only became possible with the passage of SECURE 2.0 in 2023 is rolling the funds over to a Roth IRA account, transforming the funds from an education-funding-only status to a more long-term purpose: retirement funding. We covered this option previously, noting that there are a few conditions that must be met when doing such a rollover:

• the 529 Plan must be at least 15 years old (for example, opened for a young child who is now a college grad);
• the beneficiary of the 529 Plan must also be the owner of the Roth account;
• the owner of the Roth account must have earned income equal to the amount of the rollover;
• rollovers in any given year cannot exceed the allowable amount for Roth IRA contributions ($7,000.00 in 2025);
• there is a $35,000 lifetime maximum for such rollovers.

Leave the plan alone.

Of course, there’s no actual requirement that you do anything with the excess funds. It may even be to your advantage to just let them sit in the plan and continue to accumulate tax-free. Who knows? Your recent graduate may decide, in a year or two, to go to law school or medical school or to seek some other advanced degree or training. If that happens, the funds could be used to defray the related expenses. For that matter, the plan could simply remain “dormant” until a grandchild enters the picture. After all, there’s nothing wrong with allowing the funds to compound and grow over the years, increasing the eventual benefit for a potential future generation.

Change the beneficiary.

Perhaps there’s a younger sibling or cousin coming along who could use the funds for education expenses. You can change the beneficiary of the plan from the graduate who no longer needs to funds to a younger person who does. And remember that 529 plans aren’t just for college expenses; they can also be used to pay qualified expenses for private K–12 education.

Review penalty-free, non-qualified withdrawal options.

There are even a few situations where funds can be withdrawn penalty-free, even if not used for paying educational expenses. The death or disability of the beneficiary creates one of these, but beyond such tragic circumstances, if a student is accepted into one of the US military academies (meaning that all their educational expenses are covered), funds may be withdrawn from that student’s 529 plan without penalty. Similarly, if a student with a 529 plan is awarded one or more scholarships, funds may be withdrawn from the plan up to the award amount and used for non-qualified purposes without triggering the tax penalty. However, ordinary income tax will be assessed against the amount withdrawn that is attributable to earnings on the account.

Take the hit and spend (or save) the money.

If all else fails, you can always withdraw the funds, pay the tax penalty and the ordinary income tax on the earnings amount, and do what you want with what’s left. You could even have the distribution paid to the beneficiary, since they may be in a lower tax bracket and thus subject to less taxation on the earnings portion (though the 10% penalty will still apply).

At Aspen Wealth Management, we know that many of our clients are committed to providing education funding for their children or grandchildren. If you have questions about 529 plans or other educational funding options, please visit our website and read our article, “Want to Help the Grandkids but Not Sure How? Keep Reading.”