If your children have finished college and were fortunate enough to receive scholarships or attend less expensive schools, you may find yourself with some leftover money in their 529 College Savings Plans. If so, New Jersey 101.5's recent post, "Options for extra 529 college savings," says that you have several choices for leftover 529 funds.
One of the cool things about 529 plans is that you can change the beneficiary to another qualifying family member without tax consequences.
When you are selecting a beneficiary, avoid skipping generations. If you do not, you may trigger a tax penalty. Remember, you don't have to use these funds immediately, so if your kids think that they might want to pursue a graduate degree or other professional program later on, you can save the funds and use them in the future. Parents who are interested in continuing their own education can make themselves the beneficiary.
Another benefit of 529 plans is that there is no time limit on when you must spend the savings, which gives you the opportunity to leave any unused money as an educational legacy to your grandchildren. In addition, your estate planning attorney may suggest that you one day use a 529 plan as an estate-planning tool. 529 plans offer a unique opportunity: the value is removed from your taxable estate, but you are still able to retain control of the account. Talk to your attorney to learn more.
Contributions are treated as gifts for tax purposes, so if you go ahead and withdraw the funds for non-qualified expenses, you can take a non-qualified withdrawal. Your contributions were made with after-tax dollars, so they will not be taxed or penalized. But earnings on your investments are be subject to income tax as well and a 10% penalty.
You cannot take a principal-only withdrawal from your 529 plan. Every withdrawal is part contribution and part earnings; if there are gains in the account, you are going to pay taxes and a penalty on every non-qualified distribution.
Reference: New Jersey 101.5 (March 29, 2016) "Options for extra 529 college savings"