529 Plans Provide a Smart Savings Vehicle to Fund Your Child’s College Education, and New Options and Features Make 529s Even More Beneficial
Even if you do not have children old enough to be thinking about college just yet, it would be hard to escape the news on what is happening at colleges and universities right now, along with the fact that a college education has been rising exponentially for decades to almost incomprehensible figures.
Planning and financing a college education for a child is one of the biggest expenses you will face over your lifetime as parents, so planning ahead and finding smart ways to maximize what your child will receive for assistance at application time is critical.
One of the best ways to grow education savings is with a 529 college savings plan.
Investing your college savings for a child in a 529 plan allows that savings to grow tax-free. And withdrawals, if used for qualified college-related expenses, are free of tax.
Also, contributors to 529s can benefit from tax savings in some states.
Massachusetts residents contributing to a qualified 529 plan can claim a state income tax deduction of up to $1,000 for single filers and up to $2,000 for married persons filing jointly. In Rhode Island, single filers can deduct up to $500, and married people up to $1,000.
Since its inception in 1996, the main drawback of the 529 education-savings plan has been its relative inflexibility.
If the beneficiary did not go to college, or they did not use all the funds, the owner (usually parent) of the plan had few options for the account savings and faced tax penalties for withdrawing funds for other uses if they did not have another beneficiary to transfer the funds to for college costs.
Some recent changes to the rules make the 529 plan a more flexible option for parents. The SECURE Act 2.0 was signed into law in December 2022. One provision of the act, effective this year, allows for owners of a 529 plan to move unused funds in the account into a Roth IRA for the beneficiary.
New Rollover Rules
As of January 2024, 529-plan account owners can now make tax- and penalty-free rollovers of unused funds to Roth individual retirement accounts if the beneficiary is the original beneficiary or a family member.
Here are some limits and restrictions on the rollovers:
- A provision in the Secure 2.0 retirement-savings act allows up to a lifetime limit of $35,000 in unused 529 funds to be rolled over into a Roth IRA.
- 529 contributions and earnings in the last 5 years cannot be rolled over.
- The 529 account must have been open for at least 15 years.
- Rollovers are considered contributions to the Roth IRA and are subject to the Internal Revenue Service’s yearly contribution rules. This year the limit for those under age 50 is $7,000. The beneficiary must have earned income, and the rollover amount is whatever is less, the earned income or the contribution limit.
529 Contribution Limits
There are options when considering how much to contribute to a 529 plan. It may also depend on your overall financial plan and when you start (how old your child is). It is best to think of college funding as part of your overall financial picture.
Here are some limits for funding a 529 Plan:
- In 2024, you can contribute up to $18,000 per beneficiarya year before needing to file a gift-tax return with the IRS.
- Married couples filing jointly can contribute up to $36,000 per child.
- There is also a “superfund” option. The IRS allows a per-child contribution of $90,000 in 2024 without gift-tax implications. Married couples can each contribute up to $90,000 for a total of $180,000.
- A caveat with “superfunding”: You cannot make any additional contributions to the same beneficiary for the next five years.
- Total 529 balance limitsare determined by the state you live in and fall somewhere between $235,000 and $500,000. (Massachusetts is $500,000 and Rhode Island is $520,000.)
Types of 529 Plans
- College Savings Plans: These work like a 401(k) or IRA by investing your contributions in mutual funds or similar investments. The account will go up or down in value based on the performance of the chosen investments.
- Prepaid Tuition Plans: These allow for the pre-purchase of tuition based on today’s rates, primarily at a public institution. (Be sure to check with your state for options and all requirements and restrictions.)
529 Plans Owned by Grandparents and Relatives – and Federal Financial Aid
In many families, grandparents (or other relatives) like the idea of creating a 529 college savings plan for their grandchildren or family members.
In the past, this affected a student’s eligibility for financial aid.
Under the new rules, the grandparent or relative accounts no longer factor in and no longer count against the beneficiary’s calculations for federal financial aid. (Some schools that use the CSS Profile form in addition to the Federal Application for Student Aid may factor this in.)
Considering the 529 Plan Option for College Funding
The features of the 529 plans make a compelling option for parents and families to save for college in a tax-efficient way. And the new Roth IRA rollover option can help your college graduate or college-aged child start to build their retirement savings.
If you are considering a 529 plan, be sure to compare plans and understand all your options thoroughly and ask for advice from your trusted financial advisor to be sure you make a decision that is best for your situation.
-DC