College Savings - 529 Plan Changes

College Savings – 529 Plan Changes

With continuously rising costs of higher education, college savings for your child has become more of a priority than ever. When it comes to savings vehicles for your children’s college, 529 Plans are always the first one mentioned. This is for good reason, as 529 Plans offer quite attractive tax benefits. Once you feel your debt repayment, retirement savings, and other personal goals are on track, it can be beneficial to start thinking about funding a 529 Plan for your child.

529 Plans have quite a few benefits but can be limited to what you use funds for if you don’t end up using all of the money for qualified educational expenses. There have been recent changes that are important to this matter, making the funds that may be left over in a 529 Plan more flexible to use for your child’s future.

With that said, let’s dive into 529 Plans and the changes ahead.

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What is a 529 Plan?

The most popular vehicle at the moment for college savings is the 529 college savings account. This is basically a Roth IRA for college. You make after-tax deposits into the account. Any investment gains are tax-free. You can withdraw the money from the account tax-free if the money is used for college expenses.

If the money withdrawn isn’t used for college, you must pay income taxes on any investment gains, plus a 10% penalty.

These accounts are super flexible. The limits on contributions are very high. Most plans will let you add money until the balance is around $450,000 currently. And that amount adjusts over time to account for inflation.

You (the parent) are typically the account owner and name a beneficiary on the account (your child). You can change the beneficiary at any time to another child. If your kid gets a scholarship, most plans enable you to withdraw the equivalent value of the scholarship without penalty.

Bottom line, the government wants our children to go to college, so they make these accounts attractive for the purpose of paying for college.

Many states offer state-sponsored 529 plans that provide state tax deductions on contributions. If you live in a state with state income taxes, it is smart to see if your state’s 529 plan has a tax incentive. If so, it probably makes sense to use a 529 plan from your state. However, you don’t have to use your own state’s plan. You can open an account wherever you choose.

I generally recommend people start with a 529 college savings plan. If the goal is to pay for more than an in-state public school, we will want to revisit the savings strategy after the 529 play accumulates a decent balance. Then, we often transition future contributions to a more flexible investment account that doesn’t penalize you if the money isn’t used for college.

Some parents plan to pay for any school in the country, but their kids end up staying in-state at a public school. Your wallet will thank your children in that scenario, but you will be kicking yourself if you have hundreds of thousands of dollars in 529 accounts that won’t all be used for college.

Pros of 529 Plans

As mentioned, the positives of 529 Plans are the tax benefits.

First, contributions grow tax-deferred and qualified distributions (distributions used for qualified education expenses) are tax-free.

Second, if you live in a state that offers state tax deductions on some of your contributions to a 529 plan, we get to take advantage of that as well.

Overall, a pretty good deal here.

Cons of 529 Plans

The primary downside of a 529 Plan is the lack of flexibility if the funds are not used.

Let’s say that you over saved and counted on your child going to undergrad and medical school. Turns out 4-years of undergrad was enough for them and the funds in the account remain unused. Well, you have two options:

Transfer the funds to another beneficiary, like another child, grandchild, niece/nephew, etc.
Withdraw the funds. With this option, you must pay taxes and a 10% penalty on the investment growth in the account. Since your contributions are post-tax, those funds are withdrawn tax and penalty free.

For many families, neither of these options are very attractive. That is why generally, we suggest not over-funding 529 plans and being conservative with the estimated need for college savings funds. If you want to be more aggressive with your child’s college savings, using a mix of 529 Plans and a non-retirement investment account may be a good idea.

With that in mind, recent changes to 529 Plans have allowed another option for what to do with a portion of unused 529 Plan funds.

If you have questions on your child’s college savings plan or how to incorporate this into your overall financial planning strategy, reach out to us to connect with one of our financial advisors who can help bring these items together.

Changes to 529 Plans

The major changes that have come with 529 Savings Plans is the ability to rollover a portion of your child’s unused 529 Plan funds to your child’s Roth IRA.

Starting in 2024, 529 account holders will be able to transfer up to a lifetime limit of $35,000 to a Roth IRA for a beneficiary.

This is a significant change, as now not only can 529 Plans be used for college savings, but also can play a large role in helping them save for retirement if you have up to $35,000 of unused funds in the plan.

A Roth IRA is a retirement savings tool that allows funds in the plan to grow tax-deferred and qualified withdrawals are tax-free (qualified meaning withdrawn after age 59.5 or other extenuating circumstance). The limit for Roth IRA contributions is $6,500 for 2023. Roth IRA’s can play a crucial role in a person’s retirement savings plan as it can provide a vital source of tax-free income in retirement.

The rules for the 529 Plan rollover to a Roth IRA is as follows:

Lifetime rollover limit of $35,000.
Must be rolled over into the Roth IRA in the same name as the 529 Plan beneficiary.
Can only contribute up to the contribution limit each year.
Must have the 529 Plan opened for 15 years before utilizing this rollover feature.

Let’s work through an example here.

Let’s say Jane has $30,000 of unused college savings funds in a 529 Plan, established by her parents. Below is a breakdown of how this can be used to rollover to Jane’s Roth IRA over the coming years.

*We are assuming the contribution limit stays at $6,500 each year and that the account has been opened for the required 15 years. For simplicity, we will also assume that the 529 Plan funds do not grow or decline in value over that period.

Year	Rollover to Roth IRA	Remaining 529 Plan Funds
2023	$6,500	$23,500
2024	$6,500	$17,000
2025	$6,500	$10,500
2026	$6,500	$4,000
2027	$4,000	$0

Despite this new option limiting the inefficiency of the unused funds in a 529 Plan, it should not be a primary reason for you to overcontribute. Of course, if you have more than $35,000 left in the 529 Plan, we run into the same issues.

Also, these rollover funds count as the person’s Roth IRA contributions for the year, so by rolling over funds to the plan, they will not be able to contribute or will reduce the amount they can contribute that year, up to the maximum.

Summary

Overall, this is a very positive change to 529 Plan distribution options as your child will be able to use some excess funds to help jumpstart or assist in their retirement savings plan, as opposed to withdrawing with taxes and penalty or, having the funds passed down to someone else.

It is still very important to be as efficient as possible with this money and is important to speak to a professional before getting yourself in a bind by overcontributing to a child’s 529 Plan.

If you have questions on 529 Plan funding and your child’s college savings, reach out to a financial advisor to receive a professional opinion.

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Disclosures:

This should not be construed as individual investment or tax advice. Consult with your tax professional to learn the tax implications for your particular circumstances.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses, summary prospectuses and 529 Product Program Description, which can be obtained from a financial professional and should be read carefully before investing. Depending on your state of residence, there may be an in-state plan that offers tax and other benefits which may include financial aid, scholarship funds, and protection from creditors.. Before investing in any state’s 529 plan, investors should consult a tax advisor.