Let’s admit it, every parent wants their child to go to college, right? But for many parents there is a nagging question in the back of their mind asking “what if my child doesn’t go to college, what happens to the money I’ve saved in my 529 plan?”
A 529 college savings plan is a great vehicle for families to save and pay for college; see our blog 529 college plan basics. Money invested into a 529 plan grows tax deferred and if it is withdrawn for a qualified educational expense, including recently added computer technology, is federally tax free. It is a great savings vehicle for families who start saving early and can get comfortable with the question “what happens if my child doesn’t go to college?”
For the purpose of this discussion, there are a couple terms we will be using and I want to make sure we are all on the same page with what they mean.
- Account Owner / Owner: This is the person who opens the 529 college savings plan and generally the person who funds the account, although funds can come from anyone. The 529 plan is in this person’s name and it is usually the parent of grandparent of the college-bound child.
- Beneficiary: This is the person designated to receive the money from the 529 college savings plan. This is the child the money is intended for.
- Principal: This represents every dollar you have put into the 529 plan over time. Each deposit you make or is made by others is part of the principal. For example if you invested $100 per month over the course of 18 years, your principal would be $100 x 12 (months) x 18 (years) = $21,600.
- Growth: This represents the money your principal has made over time due to the investments of the plan. For example, if the $100 a month you invested above grew at a 4% annual interest rated it would be worth $31,664 after 18 years. Your growth would be $31,644-$21,600 = $10,044.
- The principal in a 529 plan can be withdrawn without penalty. The account owner without federal tax penalty can withdraw the principal money deposited into your 529 college savings plan at any time. If you received state benefits for your deposits, you should look into possible consequences at a state level as this varies by state.
- The growth can be withdrawn for any purpose but unless it is used for a qualified educational expense (tuition, supplies, books, computers and room and board if the student is enrolled at least half time), is subject to:
- Income tax: Income tax is assessed for all long-term investment growth
- A 10% penalty: This penalty is often what prevents parents from taking advantage of a 529 college savings plan as an investment vehicle.
- 529 plans can be transferred: If the intended beneficiary decides not to go to college the beneficiary can be transferred without taxes or penalty to any member of the family: siblings, parents (to be used for post secondary education) or your child’s children creating a nest egg for your grandchildren to use for college.
- If you chose to withdraw your principal and growth for something other than a qualified educational expense, it is possible you will still have made money on your money. Using the example above you would pay taxes and penalties on the growth of your 529 plan which is $10,066:
- 10% penalty = $1,007
- Income Tax (assuming a 25% federal tax bracket): $2,517
- Money received = $6,542 less any state specific taxes and penalties.
Planning for the future of your child and your family can be tough, we understand and have spent time researching these options so we can help you make the best decision for your family. If you have any questions or comment, feel free to leave them below.
We do not intend to suggest all 529 college savings plans will make money and/or perform at a 4% growth rate per year. For more information about selecting a 529 plan read “How to select the right 529 plan for your family“.