Here's What Happens When You Have a 529 Plan and Your Child Opts Out of College

Many parents are motivated to save and invest money for college, so their children can avoid debt when getting a degree. If you've been hustling to set aside funds for your child's education, you may have opted to open a 529 plan. 

The upside of saving for college in a 529 plan is that investment gains in these accounts are tax-free, as are withdrawals taken to pay for qualified education expenses. So let's say you manage to pump $40,000 into a 529 plan through the years, only thanks to your investments, you wind up with a balance of $90,000 by the time your child is ready to head to college. In that case, you're looking at $50,000 in gains you don't have to pay any taxes on.

But what if your child decides to opt out of college? Maybe they want to work full-time right away or start a small business.

You may not want to simply hand them the money in their 529 plan, as doing so could mean facing a costly 10% penalty (though to be fair, that penalty applies only to gains in a 529 plan, not principal contributions, since those go in on an after-tax basis). Plus, you'll also be taxed on those gains, and that's another expense you may not want to deal with. But here are some other options you can consider instead.

1. Switch your beneficiary

Just because one child of yours has opted out of college doesn't mean your remaining children will follow their lead. With a 529 plan, you can switch beneficiaries easily. So if you have another child who intends to go to college, you can simply hand that money over to them.

You can also designate a 529 plan beneficiary that isn't your child. Let's say you only have one child, but you're close to your niece and nephew. You could designate them beneficiaries of your account if you no longer need it to pay for your own child's education.

2. Roll up to $35,000 into a Roth IRA

Saving money in a Roth IRA is a great way to grow retirement wealth. Starting next year, you have the option to roll up to $35,000 in unused 529 plan funds into a Roth IRA without penalty. So if your child decides to opt out of college but you still want them to have the money you were saving for their education, you can roll it into a Roth IRA and reserve it for their retirement. 

The one drawback of saving for college in a 529 plan is that taking withdrawals for non-education purposes could have negative financial consequences. But thankfully, you have options for putting that money to good use, even if your intended beneficiary decides to opt out of college. So if that's the boat you're in, think through your choices carefully, but know that you're not doomed to be penalized on the money you've worked hard to save.

That said, it's always a good idea to discuss your child's wishes for college once they're old enough to get a handle on them. That could help you avoid having to scramble to find a good use for your 529 funds.