What to Do With A Leftover 529 Plan

Despite the burgeoning cost of higher education these days, some parents might still find themselves sitting on a 529 account that was not depleted after the beneficiary (their child) has graduated from college. As you may know, if you withdraw that money for purposes other than for your child’s education, you’ll have to pay taxes plus an additional 10% penalty on the earnings in the account. Is there another way you can utilize the leftover money while avoiding the taxes or penalties? 

Yes! Here are some tax-free and penalty-free withdrawal options for your child as of 2026: 

• Use it for additional education. The money can be utilized for graduate school for your child just as it was for college. It can even be applied to qualified vocational and trade schools and even for qualified certificate programs and continuing education courses.

• Use it to fund a Roth IRA account. You can make a Roth contribution from your 529 account to your child’s Roth account if (1) the 529 has been open for at least 15 years, (2) the funds have been in the account for at least 5 years, and (3) your child has earned income. The amount you can contribute each year counts towards the child’s Roth contribution limit and is also constrained to a $35K lifetime maximum. Note however that some states do not recognize a distribution for this purpose as being tax and penalty-free. California will tax the withdrawal as well as impose a 2.5% penalty.

• Use it as an estate-planning vehicle. Since there is no time limit for spending money in a 529 plan, you can bequeath the account to your child for the benefit of their children. You retain control of the account until you die and can continue to make annual gift-tax exclusion amount contributions (currently $19,000) until the lifetime contributions reach your state-mandated limit ($529K in California). Plus, after you pass away, the 529 account is not counted as part of your estate for estate transfer tax purposes. 

Here are some ways you can help others while still avoiding any taxes and penalties:

• Use it for another child. You are allowed to change the beneficiary of the 529 plan to another qualifying family member without any tax consequences. If you have other children soon to enter or currently in college, the money can be used to pay for their qualified expenses even if you have other 529 plans set up for them. Money in 529 plans can also be used for younger children’s private elementary and secondary education as well (although limited to $20K per year as of 2026). 

• Use it for another relative. The IRS allows you to change the beneficiary not only to siblings but also to parents, aunts, uncles, nieces, nephews, stepparents, and even first cousins. However, check with a tax professional before changing the beneficiary to a grandchild or other lower generation family member. That could trigger a generation-skipping estate tax.

• Use it for your own career.  Either parent qualifies as a successor beneficiary. Whether you are interested in improving or changing your career or simply want to enjoy earning a new degree in retirement, the 529 can be used tax & penalty free. 

There are also some ways to avoid the 10% penalty (although still incurring taxes on the earnings):

• Use it to offset any scholarships your child received while in college. You can withdraw an amount equal to all tax-free scholarships received without penalty. The withdrawal will be taxed based on the percentage of earnings in the account, since it’s only the earnings (not the original contributions) that are taxable. You cannot choose to distribute the contributions first.

• Use it for a disabled beneficiary or for one who enlists in the military. As with the above, you’ll still need to pay taxes on the distributions but will avoid the 10% penalty.

If none of the above apply, you can always withdraw the money and pay the taxes and the 10% penalty (plus any state taxes and penalties). If the distribution is made directly to the beneficiary the taxes and penalty will be owed by them, not you. If that’s your child, their tax rate might be lower than yours. And since none of the original 529 contributions are taxable, the amount owed to the IRS may be less than you think. 

(Sources: IRS, SavingforCollege.com)