MoneyLife

Can I Avoid 529 Penalty Fees? 

By Grace Kilander
529 penalty

A 529 plan is a great way to set your loved one up for success and alleviate some of the stress associated with figuring out how they will pay for higher education. But what if the loved one no longer needs the funds that you worked so hard to put aside for them? 

You can withdraw from a 529 plan, but there is a penalty for doing so. However, there are certain ways by which you can avoid paying penalty fees by reallocating the funds and ensuring they are used appropriately. Let’s take a look at what a 529 penalty fee is. 

What is a 529 penalty fee?

A 529 penalty fee is a payment that you’ll incur when you withdraw from a 529 plan and use that money to pay for something that is considered an unqualified expense. In other words, an unqualified expense is anything that is not an educational expense. 

Fortunately, a lot of expenses qualify as educational expenses under the terms of a 529 plan. Even so, there are some one-offs that don’t qualify as educational expenses. For example, books or a laptop would qualify as educational expenses. 

On the other hand, a purchase like a vehicle would not be considered an educational expense, even if the student needs the car to get themselves to and from campus. This can be challenging, but since a 529 plan allows for tax-free investments, there are certain restrictions regarding how you can use the funds in a 529 plan. 

There is a 10% penalty imposed in any situation where you use your 529 funds and put them towards unqualified expenses. Additionally, your 529 plan funds might be subjected to state taxes, though this amount will vary from one state to the next.

It is up to you to decide if the fee is worth the purchase you want to make. But how do 529 penalties work? Let’s find out! 

How do 529 penalties work? 

The earnings of a 529 plan are subjected to penalty fees when they are used for unqualified funds. This means that the money in your 529 plan might face penalties, aside from the funds that have been contributed over time. 

Upon withdrawing the money that you intend to use for nonqualified expenses, those funds will be reported. The account owner, known as the beneficiary, will be expected to pay the 10% penalty and take responsibility for the taxes when they file their income taxes. 

4 ways to avoid 529 penalty fees

So, you’ve decided that you’re not going to attend college yourself, but you still have a 529 plan. You might be thinking, “How can I withdraw from my 529 plan with no penalty when I am choosing not to go to college? Is that even possible?” Well, there are a few ways that you can avoid penalties while still benefiting from your 529 plan! 

Pay student loans 

A 529 plan can be used to pay back any student loans on behalf of the beneficiary or the siblings of the beneficiary. The only caveat to this option is that no more than $10,000 can be put towards your student loans. Plus, not all states allow this in the first place. 

Check the regulations for the state you are in to see if your state permits people to use their 529 plan funds for the purpose of paying back student loans. These limitations also apply to the parents or creators of the 529 plans as well. 

Want to start paying off your own student loans? Then make yourself the beneficiary! Even though you’ll still be limited to $10,000 per year, the remaining funds can be used for the sake of securing other financial goals or starting a rainy day fund

Change the beneficiary 

Did you know you can change the beneficiary of a 529 plan once per year? Let’s say you planned to create a 529 plan for your child but your child ends up receiving a full ride to college.

In the event that this happens, you can choose to change the beneficiary and transfer the ownership of the 529 plan over to another family member. The best part is that this is possible with no costs and no penalty fees. 

The beneficiary can be just about any family member, too. Whether that’s another child, a sister, or a brother-in-law, you can even transfer a 529 plan over to a grandchild. This is a great way to bypass penalty fees. 

But like we said, you can even make yourself the beneficiary if you want to use the funds for the purpose of paying your own student loans. This is a great idea, especially if you’re considering the idea of pursuing higher education. 

Pay for the K-12 education of a sibling

If the original beneficiary of the 529 plan chooses not to pursue higher education, you can use the 529 plan to pay for the K-12 education of another child. This option is still limited to a maximum of $10,000 per year, though the money can be used for private school tuition as well. For example, if an older sibling chooses not to go to college, the younger sibling could then use their 529 funds to pay for their private school education. 

Fund an apprenticeship 

In 2019, the SECURE Act was passed, which then expanded the benefits of a 529 plan immensely. Ever since then, you can now use a 529 plan to fund a registered apprenticeship! 

As long as the apprenticeship is registered with the U.S Secretary of Labor, funds from a 529 plan can be used to pay for the required fees as well as any supplies that are required as part of the apprenticeship. If you were considering a non-traditional avenue when it comes to pursuing your career goals, you can still use your 529 funds with no penalty. 

Are the 529 penalties really that bad?

Depending on how badly you need the money, the 529 withdrawal penalty might be worth accepting. It is important to recognize that a 529 plan is intended to be used as a resource for educational purposes. 

As such, a 529 plan is not typically intended to be used for unexpected expenses, though it can be used as a safety net in the event of an emergency. But thankfully, there are some accounts that are specifically designed for stressful financial circumstances. 

For example, an investment account with MoneyLion makes it possible for you to withdraw money without any penalties or fees. This is a great way to not only plan for your financial future but also have emergency funds when surprises pop up. With a 529 plan and a MoneyLion account, you can use your 529 plan funds the way they were intended to be used as opposed to being considered a rainy day fund. 

Plan for your educational and financial future

It is estimated that 69.1% of high school graduates plan to attend college. However, it is possible that the student you opened a 529 plan for will choose not to attend college in the future. 

If that happens, you’ll have a 529 plan with money in it and no one who can use it. But thankfully, there are other options for you to pursue if you want to use the funds without taking on any penalty fees. 

It can be tempting to use the money in a 529 plan when the funds are just laying around and nobody has plans to use them. Options like the Safety Net feature from MoneyLion can help you secure your finances while providing you with helpful resources if and when you need extra money in your pocket. 

This can help you steer clear of the temptation to use your 529 plan funds so that the money in your 529 plan can continue to grow unbothered. You will also be able to avoid losing money as a result of penalty fees, too. 

With the Safety Net feature, you can receive your direct deposit up to two days early. Plus, you’ll gain access to upwards of $1,000 in 0% APR cash advances. 

Leave your 529 plan alone and only use those funds for educational purposes! You can do this by turning to MoneyLion and taking advantage of the MoneyLion financial tools to keep you covered when you need cash in a pinch.

FAQs

What happens if you don’t use 529 money for college?

You can put the funds towards any loans you take out, or you could consider changing the beneficiary of your 529 plan if you don’t intend to put the funds towards college-related expenses in your name.

Can I buy a computer with 529 funds?

Yes, a computer counts as a qualified educational expense.

What is the maximum amount of money you can contribute to a 529 plan?

The maximum contribution limit varies by state. It is important to note that as a rule of thumb, a 529 plan should contain enough money to cover at least five years of college tuition as well as the costs of room and board.

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