by Daniel Kittell | Accounting News, News, Newsletter
Investing in a 529 plan – typically regarded as the best way to save for a child’s college education – has become a more attractive savings vehicle thanks to a new federal law going into effect this year. Read on to learn more about the change affecting 529 plans.
What is a 529 Plan?
A 529 college savings plan is a state-sponsored investment account that enables you to save money for a beneficiary and pay for education expenses. These plans offer tax-free earnings and withdrawals for tuition and other qualified higher education expenses (QHEEs) such as tuition, supplies, and room and board. Additionally, due to the 2017 Tax Cuts and Jobs Act, the funds in a 529 plan can also be used for elementary or high school tuition for private or religious schools (with QHEEs capped at $10,000 per year).
However, 529 plans have always had a limitation worth considering: the money in a 529 plan could only be used for education. Withdrawing the funds for other purposes would draw penalties, so if you set up a 529 plan and your child ends up not needing it – whether they attend public school, get a full scholarship to college, or decide against a college path – accessing the funds without accruing penalties typically necessitated changing the beneficiary on the plan to someone else, until now.
How are 529s Changing?
Previously, withdrawals from a 529 plan for non-QHEEs incurred a 10% federal tax on the earnings portion of the withdrawal, in addition to potential state taxes. However, as of January 1 of this year, unused funds from a 529 plan can be rolled over into a Roth IRA account tax-free.
Rules for Rollovers
There are still some rules and restrictions that are important to know.
- Rollovers are not allowed until a 529 plan has been open for at least 15 years
- Funds converted from a 529 plan to a Roth IRA must have been in the account for at least five years
- A maximum amount of $35,000 can be rolled over from a 529 plan to a beneficiary’s Roth IRA
- Annual Roth IRA contribution limits apply to rollovers (the contribution limit in 2024 is $7,000)
- Conversions are limited to the beneficiary’s Roth IRA, meaning parents cannot convert the unused funds of a 529 plan in their child’s name back into their own retirement account
No Additional IRA Investments During Transfer Years
Because the annual contribution limit is restricted to $7,000, if you transfer the full $7,000 from a 529 plan to a Roth IRA, the account holder will be unable to contribute additional funds through another traditional IRA or Roth IRA within that year because the annual limits are already being monopolized by the 529 to Roth IRA conversions each year. Ideally, the beneficiary also has a tax-advantaged retirement account like a 401(k) through an employer.
Keep in mind that the 15-year minimum for an account means that you’ll need to think about the long game. If you’re interested in starting a 529 plan for your child, you might think about establishing it with a small amount even before you’re ready to begin contributing to it.
by Daniel Kittell | Accounting News, News, Tax, Tax Planning - Individual
Enrolling in a 529 plan is the first step toward conscious planning for your child’s college education, but don’t stop there. With college costs rising steadily — over 168 percent over the last 20 years, according to U.S. News — it’s important to maximize the value of your plan to ensure you reach your college savings goals.
First, it’s important to know the specifics of 529 plans. For instance, there are two different types of these state-sponsored plans available:
- Probably the most well-known, the college savings plan allows your money to be invested in a variety of ways, such as mutual funds and the like, and it will compound interest over time. The account will go up or down in value based on the performance of the investment options.
- A pre-paid tuition plan allows savers to purchase units on a credit-based system to put toward tuition and fees for campus living, excluding secondary expenses such as room and board. Because prepaid plans allow you to lock in current tuition prices, if budgeting is a priority, this plan might be the best fit. Just be sure to check which colleges and universities participate in the plan because not all do.
Start early
Because 529 plans compound tax-free over time, starting early gives you an advantage. The longer the money is in the account, the more time it has to grow.
Take Advantage of Automatic Contributions
Automatic contributions to 529 plans can commonly be withdrawn from a linked checking or savings account. This makes it easier to stay on track to reach your goal. If financial situations change, account holders can adjust this setting in their account and continue to make contributions when it’s practical.
Be Mindful of Rules and Fees
Like IRAs, you make yourself vulnerable to penalty fees if you withdraw earnings from a 529 plan too soon, like withdrawing funds before the beneficiary’s tuition bill is due, which could incur a 10% penalty fee. Likewise, withdrawing more than allotted for qualifying expenses that year will prompt a fee. Though non-qualifying expenses, like medical bills, will provoke a penalty fee, there are some exceptions to this rule, such as if the beneficiary receives a scholarship or another type of educational assistance.
Both prepaid and college savings plans typically include enrollment and administrative fees when you withdrawal funds, but college savings plans may also add an assessment management fee.
Cut the Middle Man—You
An effective way to use your 529 funds to ensure that you’re not taking out more than your expenses, and thereby causing a tax liability, is to have the plan pay the costs directly to the school with direct payment.
Know How Your State Operates
Individual states make their own rules for 529 plans, so in whichever state you set up your 529 plan, it’s important to understand that state’s benefits, drawbacks, rules, and fees. State income tax deductions will also vary by state.
Withdraw from the Correct Fund
If you have more than one 529 plan, be sure you’re not just randomly withdrawing from any of them, or simply withdrawing from the account with the highest balance. Gauge each plan’s growth potential to determine which one has the best investment growth rate, and tap into those savings to receive the best tax breaks.
Involve Extended Family
Relatives have the ability to contribute to or open a 529 plan to help alleviate the burden for parents and students, and the contributor is eligible to take a deduction as long as it’s offered by that state.
Knowing the ins and outs of a 529 plan can be complex, but the simplest way to maximize your plan is to start early, allowing the funds to accumulate over time.
