It’s important to put money aside to finance your children’s college educations. But not every kid goes to college. So, what do you do when your child decides to go in different direction? What happens to that college savings fund you tucked away all those years? This article discuses some of the most common methods you can use to save for college and what happens to them if your children decide that college is not an option.
What to Do With 529 Savings Plan Funds
One of the most common solutions for college planning is the 529 savings plan. These are tax-advantaged investment plans operated by states or educational institutions. They provide an incentive, in the form of a tax deferral, to set money aside to fund the education of a designated beneficiary.
A key point about 529 plans is that they aren’t just for college. They are education savings plans that can be used for education expenses that occur before a student attends college. For example, they can be used to fund K–12 tuition expenses.
If your children attend public school and have no tuition expenses, then your 529 plan might grow right up to the point where they reach college age. What can you do if they then decide college isn’t for them. Are your children entitled to the money in the 529 plan? Can you just give it to them?
Someone who sets up a 529 account owns it, no matter who the beneficiary is. The owner can withdraw funds at any time for any reason. Withdrawn funds not used for qualified education expenses will be subject to income tax and an early withdrawal penalty on investment gains. Amounts equal to any plan contributions would be returned tax and penalty-free.
Since named beneficiaries of a 529 plan have no claim to the money, you can make another family member, including yourself, the beneficiary. If there are no younger siblings attending college, and no need for college funding, then withdrawing the money and paying the penalty is an option.
Alternatively, you could name a niece, nephew, or even a non-family member as the new beneficiary.
Comparing 529 Plans to Coverdell Education Savings Accounts
What are the options if you set up a Coverdell Education Savings Account instead of a 529 plan? How would withdrawals be handled if your child decided to not attend college?
A Coverdell Education Savings Account has some similar consequences for unused funds (e.g., gains are subject to income tax and a withdrawal percent penalty). However, unused funds go to the beneficiary. So, parents can’t just pull the money out the way they could in a 529 plan.
Your child may still use the money in a Coverdell account even if he or she doesn’t attend college. Coverdells have a slightly broader definition of qualified educational expense than a 529 plan. And beneficiaries have until age 30 to use the funds, which can also be converted into a 529 plan.
Other College Savings Plans
What about those old custodial accounts, like UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act)? These accounts create an irrevocable transfer of assets from an adult to a minor. A potential advantage of this transfer is the child’s lower tax rate.
When the child reaches the age of majority, he or she owns the assets and can use them without restriction, whether for college or any other use.
Roth IRAs and Other Investments
Contributions to a Roth IRA are funded with after-tax dollars. Since money going into a Roth IRA has already been taxed, money coming out is a tax-free source of retirement income (provided the owner is over age 59 ½ and the account has been funded for more than five years).
Those over age 59 ½ who funded a Roth IRA more than five years before, can withdrawal money from the account tax and penalty free. But even if you don’t meet the age and holding period requirements, you can still use your Roth IRA as a source of college funding.
This is because the withdrawal rules of Roth IRAs waive the early withdrawal penalty when the money is taken out to pay for higher education expenses of the plan owner or his or her immediate family members.
Some people use more traditional, less tax-advantaged methods to save for their children’s education. Among these is the classic nonqualified (i.e., taxable) investment account. This is where people typically hold mutual funds or other investments held in their own name.
These assets can be used for any purpose. The only drawback is that they have to be sold to generate cash. That means the potential loss of interest or dividend income. And those sales could create capital gains that are subject to income taxes.
But, if your children don’t go to college, this is a non-issue.
Why Using a College Savings Plan Makes Sense
Parents with young children should fund separate accounts like 529 plans (or other programs) to help fund their college savings plans. If you want your children to attend college, it makes sense to plan for it well in advance.
You should do this very early on – even before the kids are old enough to understand what college is. The earlier you start the more you can set aside. All investment decisions should be considered carefully and thoughtfully in coordination with trusted advisors. It also makes sense to have a backup plan.
Use our College Savings Calculator to get started. Or reach out to a Member Service Representative for insight into the options available to save for your children’s education.