New Options for 529 College Savings Plans
Our clients often ask us how to best save for college - either for their own children or for their grandchildren. Over the years, our advice has evolved as 529 plans have changed, becoming less restrictive.
Now, more than ever, we are suggesting clients save to 529 plans over other education savings alternatives. This is because in December 2022, Congress passed the SECURE 2.0 Act and introduced new rules relating to 529 plans. The new law now allows for tax and penalty-free rollovers from a 529 plan to a Roth IRA!
Before we get into the changes to 529 plans, we thought it would be good to review how 529 plans work, and important considerations when using this education-savings tool.
Basics of 529 Plans
529 plans are state-sponsored savings vehicles designed to help pay for expenses associated with qualified K–12 expenses or college expenses. Contributions to 529 plans are not federally tax deductible, but some states allow a state tax deduction (NC does not). The primary benefit is that investment earnings are not taxable as long as they are used to pay for “qualified” education expenses.
Generally, qualified education expenses include tuition, fees, books, supplies, equipment, room and board (with limits), lab costs, computers, computer equipment, and internet access. It is important to note that qualified K-12 tuition expenses may not exceed $10,000 per beneficiary per year.
Anyone can open a 529 savings plan account, regardless of income level. Any unused funds can be used to cover the education expenses for other siblings or family members. However, there is a 10% penalty should 529 plan funds be used for anything other than qualified education expenses.
New 529 Plan Rollover Option
In an effort to broaden the flexibility of 529 plans in situations where families have extra funds in an account, Congress created a new rollover option. Starting in 2024, 529 plan beneficiaries can roll over up to $35,000 in a 529 plan to a Roth IRA over their lifetime. The rollover is not subject to taxes or a penalty that would typically apply to a non-education use of these funds.
Here's how it will work:
The beneficiary of the 529 plan must be the owner of the Roth IRA.
Any rollover is subject to annual Roth IRA contribution limits, so a beneficiary can't roll over $35,000 all at once. For example, in 2023, the Roth IRA contribution limit is the lesser of $6,500 (under age 50), or 100% of earned income. If the limit remains the same in 2024, a beneficiary would be able to roll over up to $6,500. However, if the beneficiary earns $4,000 in total income in 2024, then the maximum amount that could be rolled over is $4,000.
In order for the rollover to be tax- and penalty-free, the 529 plan must have been open for at least 15 years. If the 529 account owner (typically a parent) changes the beneficiary of the 529 plan at any point, this will restart the 15-year clock.
Contributions to a 529 plan made within five years of the rollover date can't be rolled over — only 529 contributions made outside of the five-year window can be rolled over to the Roth IRA.
Offering the Roth IRA rollover as an option with 529 plans takes a lot of the guesswork out when it comes to “overfunding” the education account and subjecting it to the 10% penalty. This new option gives flexibility to parents to help their kids (and grandkids) establish a retirement savings plan as they start their careers. For questions about how 529 plans can fit into your plan, please contact our office.