A 529 college savings plan can become your child’s best long-term financial strategy. But not just because of the higher education it can pay for.
529 plans were created by the U.S. Congress in 1996 as a way for families to save for future college expenses. 529 plans are sponsored by states or state agencies and allow tax-deferred growth and tax-free withdrawals for qualified education expenses like tuition, fees, books, and room and board. The plans have evolved over time to become more flexible in the types of expenses they can cover. Anyone can open a 529 plan, regardless of income level, and name a beneficiary such as a child or grandchild that can use the plan for their education expenses. Recent legislation has expanded the use of 529 plans to cover K-12 tuition, apprenticeship programs, and student loan repayment.
All three of my kids had a 529 plan started for them when they were very young. Over time their 529 balances grew quite a bit due to the recent bull market in stocks. My twin boys are now sophomores in college, and I have been using their 529 plans to pay for their tuition as well as the rent for their apartments. My daughter is a recent grad of the University of Florida (Go Gators!), and I used much of her 529 plan for her college expenses as well.
College can be quite expensive these days. Housing and food costs during college can also be just as expensive. So, looking back, I can say that I am so grateful that we started the 529 plans for our kids and even more grateful to the family members who helped contribute to them over the years as gifts to my kids.
My daughter is now out of school and working as a professional for a digital marketing firm. Because she went to in-state school and avoided the higher costs of private or out- of-state tuition, there is money left over in her 529 plan. Until recently, my only option for the remaining balance would be to either transfer to it to my sons’ 529 plans or take a distribution that would result in a taxable distribution plus a 10% IRS penalty on part of it.
But as of January 1, 2024 another option became available for unused 529 balances thanks to the SECURE 2.0 Act which now allows up to $35,000 of unused 529 balances to be converted into Roth IRA retirement savings for the beneficiaries of 529 plans.
There are some restrictions and holding periods to be aware of:
The 529 plan must have been in existence for at least 15 years before the rollover can be made.
There is a $35,000 lifetime limit on the amount that can be rolled over from a 529 plan to a Roth IRA.
The annual rollover amount is limited to the Roth IRA contribution limit, which is $7,000 in 2024.
Contributions and earnings made to the 529 plan in the last 5 years cannot be rolled over.
The rollover must be a direct, trustee-to-trustee transfer - the funds cannot be withdrawn from the 529 plan and then deposited into the Roth IRA.
The Roth IRA beneficiary must have earned income at least equal to the rollover amount.
The beneficiary is not subject to the normal Roth IRA income limits for eligibility.
Changing the 529 plan beneficiary may restart the 15-year holding period, but this is still unclear.
So, with my daughter having earned income in 2024 from her job (yay!), we were able to rollover $7,000 directly from her 529 plan into a new Roth IRA account this year, which can be invested in stocks and grow tax-free over the next forty plus years until her retirement age. We could roll over $7,000 more each year over the next four years as well until the $35k limit is reached. She could also later take up to $10,000 out of her Roth IRA tax and penalty free if she wants to use it toward a first-time home purchase.
$35,000 invested for 40 years compounded at a 10% annual return could result in a $1.6 million tax-free retirement portfolio.
This new rollover option is a real game changer that makes 529 plans even more attractive. It also should be included in your consideration when determining if the extra out-of-state or private tuition costs will return the same financial security for your child or grandchild in the long term.
Best,
Gregg Pacitti CFP®
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