Contributing to the higher education costs of your children or grandchildren may seem daunting these days, but it can be within reach with the right preparation, including utilizing a 529 plan.
The SECURE 2.0 Act adds more flexibility and choices for families saving for a child’s education.
SECURE Act and SECURE 2.0
The SECURE Act was initially passed by Congress at the end of 2019 and intended to improve retirement savings opportunities. It was a big deal at the time, the most significant piece of retirement legislation since the 2006 Pension Protection Act. You can read a summary of the key provisions here.
Congress came together to pass SECURE 2.0 at the end of 2022, building on this popular legislation and clarifying some of its provisions.
The SECURE 2.0 Act includes 92 new provisions designed to promote savings, add incentives for businesses to offer retirement plans to their employees, and provide more overall flexibility to those saving for retirement.1
While increasing the starting age for required minimum distributions to 73 made the headlines, another important change for those saving for college was the addition of an option to move the unused portion of a 529 plan to a Roth IRA. But, several criteria are involved in this process, and eligibility requirements must be met.
A 529 plan is an education savings account that allows parents, grandparents, other relatives, or friends to save money that will be used for a child's education.
A 529 plan allows individuals to save for college on a tax-advantaged basis. Generally, contributions are made with after-tax dollars, earnings grow tax-deferred, and qualified distributions can be made tax-free. Earnings on non-qualified distributions will be subject to income tax and a 10% federal penalty tax.
These investment accounts became mainstream in the mid-1990s as a way for people to save for future education expenses, with the assets used to pay for qualified education expenses for a designated beneficiary. Originally geared exclusively to pay for college, 529s have been expanded to pay for K –12, private and religious schools, trade schools, graduate programs, and some international institutions.
(Many states do not comply with Federal law and, as such, do not consider K-12 education expenses as a qualifying withdrawal. These states are California, Colorado, Hawaii, Illinois, Michigan, Minnesota, Montana, Nebraska, New York, Oregon, and Vermont. This means that 529 withdrawals for K-12 expenses in these states could end up resulting in state taxes and perhaps penalties.)
The state tax treatment of 529 plans is only one factor to consider before committing to a savings plan. Also, consider the fees and expenses associated with a particular plan. Whether a state tax deduction is available will depend on your state of residence.
529 Plans Explained
With a 529, after-tax contributions are invested in an account that can be used to pay for qualified education expenses. For example:
- Housing—Campus housing expenses, including college room and board fees, can be paid through 529 distributions. Off-campus housing rentals qualify up to the cost of room and board on campus.
- Books and Supplies—Paper, pens, and textbooks required by a specific course are qualified expenses. Schools set budget limits for books and supplies.
- Needs and Services—Special needs equipment and services qualify for 529 distributions. Students using mobility equipment may be eligible for 529 distribution purchases. Depending on the circumstances, other modes of transportation may also apply.
Also, keep in mind that a 529 plan account holder may qualify for a state tax benefit, depending on where they live. More than 30 states and the District of Columbia offer some type of tax deductions or tax credits for 529 plan contributions.2
Under the old rules, any leftover funds in a 529 plan after the designated student graduates or leaves college would be subject to a tax penalty and a withdrawal penalty if the remaining assets were liquidated for non-qualified expenses. However, the owner was allowed to transfer the 529 plan to another beneficiary, who could use it for their education expenses.3
SECURE 2.0 Act Changes for 529s
The new rule, which goes into effect in 2024, allows a 529 account holder to move money to a Roth IRA account under certain conditions. The main benefit of this new rule is that it removes some of the uncertainty regarding whether your kids will need the 529 money or whether you may have overfunded the account.
To qualify for the tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawals can also be taken under certain other circumstances, such as the owner's death. The original Roth IRA owner is not required to take minimum annual withdrawals.
Moving a 529 to a Roth IRA4
- This part of the SECURE 2.0 Act becomes effective after December 31, 2023.
- The 529 plan must have been open for a minimum of 15 years.
- Changing beneficiaries to another student may restart the 15-year clock.
- The owner of the Roth IRA must be the beneficiary of the 529 plan (meaning the student).
- Any money moved from a 529 plan into a Roth IRA account will be subject to the Roth IRA annual contribution limits. The Roth IRA contribution limit in 2024 is scheduled to be $6,500, with an extra $1,000 allowed for individuals over age 50.
- The lifetime limit is $35,000.
Paying for College
In 2021, the average cost for a year of college, including tuition, fees, room, board, and other expenses, was $35,551. That's about $142,000 for a four-year degree. 5 And for tuition alone at a private college or university in 2023, the bill for higher education rises to $42,162 per year!6
Thankfully, we have helped many clients create college savings strategies for their children and grandchildren. So, if you're considering a 529 plan, please reach out.
We’re happy to provide more detailed information about 529 plans and offer guidance and insight into the state plan you are considering. We look forward to hearing from you.
- AM.JPMorgan.com, January 3, 2023
- SavingForCollege.com, May 11, 2023
- SavingForCollege.com, April 19, 2023
- SavingForCollege.com, December 24, 2022
- BestColleges.com, April 11, 2023
- USNews.com, September 20, 2023