What to Do When Your 529 Has Too Much Money

Experts answer this and other questions about strategies for college savings

Click here to see the original article in The Wall Street Journal. It was written by Chana R. Schoenberger.

Slide Image 4

Wall Street Journal - Readers again wrote in with questions about saving for college, including strategies for using “529” college-savings plans, those popular tax-advantaged investment accounts that help many families pay for sky-high college tuitions. We asked financial experts to help answer the readers’ questions.

I’m afraid I may have overfunded my children’s 529 accounts. Now what shall I do? Stop funding? Convince them to go to expensive private colleges and earn master’s or law degrees to use up this money without penalties?

There is no way to get the money out of a 529 without paying penalties on the earnings portion unless you use it for qualified educational expenses. The only option is to change the beneficiary to another eligible family member who can then use the money for educational purposes.

If you’re willing to pay the taxes and penalties, you can retitle the account with one of your students as the owner as well as beneficiary. This allows you to “distribute to them in their probable lower tax bracket to minimize the taxes and penalties if there is not a compelling reason to continue the 529 plan,” says Beth Walker, a partner at Wealth Consulting Group, a Las Vegas financial-planning firm. You also have the option to move the funds back into your own retirement savings, but that will also incur taxes and penalties, says Gretchen Cliburn, director of financial planning at BKD Wealth Advisors in Springfield, Mo.

After my daughters graduated from college, I began working for health-care nonprofits overseas. I can’t pay my daughters’ leftover college bills on my current income, and I’m approaching retirement. Can I get the bills reduced based on my circumstances?

It depends on how the bills are structured, Ms. Walker says. If what you owe is a Parent Plus loan in your own name, you have several options, she says. You can adopt an income-contingent Parent Plus loan-repayment plan, which will lower your monthly payment and make you eligible for loan forgiveness after 25 years of payments.

“This will likely increase the total interest charged over the life of the loan but may make payments manageable from a monthly cash-flow perspective,” she says.

If you qualify based on credit and income, you could also consolidate and refinance your loan, which will decrease your interest rate. Or you could try to get into the Public Service Loan Forgiveness program, which would forgive your loan in 10 years, assuming your job qualifies you, she says.

My son’s wife works for a major university. Because of her employment, she is entitled to tuition-free education for her children. Included on her W-2 is the cost of that tuition, which is taxable to her. Can she use money from a 529 plan to pay the taxes generated by the tuition inclusion on her W-2?

Since taxes paid on an employee benefit—such as a tuition discount—aren’t considered a qualified education expense, you would have to pay taxes and penalties on the earnings portion of 529 money used to pay those taxes, Ms. Walker says.

But if you had little or no gain on the money that you have contributed to your 529, “it might still make sense to meet your tax liability with money that is sitting in the 529,” she says.

Ms. Schoenberger is a writer in New York. She can be reached at reports@wsj.com.