Key Questions: 529 Plans - What to Know and Why Should You Invest?

Why Invest in 529 Plans Now?

Updates and changes to come: A 529 plan is a tax-advantaged investment plan designed to help individuals save for future education expenses. If you have a child or loved one who will attend college or pursue other qualified education opportunities, a 529 plan provides a dedicated and tax-advantaged vehicle to save for those costs. It allows you to accumulate funds over time, potentially reducing the need for loans or financial strain when it’s time for education expenses. Here are some advantages of a 529 plan:

Tax Benefits: One of the primary advantages of a 529 plan is its tax benefits. While contributions to a 529 plan are not deductible on your federal income tax return, the investment grows on a tax-deferred basis. This means you won’t pay taxes on the earnings as long as the funds are used for qualified education expenses. Additionally, some states offer state income tax deductions or credits for contributions to a 529 plan.

Flexibility: 529 plans offer flexibility in terms of the beneficiary and usage of funds. The beneficiary can be changed to another family member if the intended recipient does not need the funds for education or if there are leftover funds. This can be helpful if the original beneficiary decides not to attend college or if you have multiple children.

Wide Range of Qualified Expenses: The funds in a 529 plan can be used for a variety of qualified education expenses. While commonly associated with college expenses, including tuition, fees, books, and supplies, a 529 plan can also cover expenses for qualified K-12 education, apprenticeships, and even certain student loan repayments. The flexibility of qualified expenses makes it a versatile tool for education-related financial planning.

High Contribution Limits: 529 plans typically have high contribution limits, allowing you to save significant amounts for education expenses. While each state sets its own limit, it is often in the hundreds of thousands of dollars. Some plans even allow you to make a lump sum contribution equal to five years’ worth of annual gift tax exclusion ($85,000 for an individual in 2023) without incurring gift taxes.

Estate Planning Benefits: A 529 plan can be an effective estate planning tool. Contributions to a 529 plan are considered completed gifts for federal tax purposes, which means they are excluded from your taxable estate. By contributing to a 529 plan, you can reduce the size of your taxable estate while still retaining control over the funds. This is something to consider as we get closer to the sunset of the current tax rates at the end of 2025.

Secure Act 2.0 Changes: Before the changes made in the Secure Act 2.0, we had a couple options with remaining funds in a 529 plan. The funds could be withdrawn, but you paid income tax as well as a 10% penalty; the only way to avoid the withdrawal penalty was to transfer them to another beneficiary within the family, such as another child or even a parent, who could use it for their education expenses.

The Secure Act 2.0 has opened the door to another option. Beginning in 2024, federal legislation changes give a 529 plan beneficiary the ability to transfer 529 plan funds into their own Roth IRA without paying taxes or penalties. Listed below are the requirements to take advantage of this option.

Eligibility and Criteria:

• The 529 plan must have been open for a minimum of 15 years.
• The owner of the Roth IRA must be the beneficiary of the 529 plan.
• The rollover is subject to the requirement that a Roth IRA owner have includible compensation at least equal to the amount of the rollover.
• Contributions made to the 529 plan in the past five years, including the associated earnings, are ineligible for a tax-free transfer.
• Transfers you make from a 529 to a Roth IRA count against your yearly Roth IRA contribution caps, which are currently at $6,500.
• The lifetime limit for rollovers is $35,000.

This third option gives us a viable option to not only help our loved one’s education but jump start their retirement savings as well.

Costs to Consider: The average cost of attendance for a student living on campus at a public 4-year in-state institution is $25,707 per year or $102,828 over 4 years. Out-of-state students pay $44,014 per year or $176,056 over 4 years. Private, nonprofit university students pay $54,501 per year or $218,004 over 4 years.

It is important to note that while 529 plans offer numerous advantages, there are also considerations to keep in mind. These include potential penalties for nonqualified withdrawals, investment risks, and the impact on financial aid eligibility. Consulting with your financial advisor can help you make informed decisions based on your specific circumstances.