For those of us with little goofers of our own running about, a 529 college savings account is a great way to start saving for their college education expenses.
Updated tax law allows for the use of 529 funds for private k-12 tuition, up to $10,000 annually. These plans are no longer used only for post-secondary expenses and there is no annual spending limit for qualified post-secondary education expenses. One upside is that there is no limit to the number of plans that can be opened for a single beneficiary. My wife and I can open one plan and the grandparents can open a plan as well; if they prefer, the grandparents, or anyone else for that matter, can contribute to the parent-owned plan – there are no limits on the number of contributors. Contributions do count as gifts to the beneficiary however, so staying below the current $16,000 per person gift tax exclusion in an important consideration. However, it is permissible for an individual to gift up to $80,000 in one year to a 529. This is a strategy called forward gifting, which allows a person to contribute five times as much money to a 529 in a single year, providing no other gifts are made during that time period.
One of the major benefits of a 529 plan is the tax-free growth and tax-free withdrawals for qualified expenses. Even if you are spending along the way, you could have quite the nest egg for college. For example: If the new grandchild goes to private school for k-12 using the full $10,000 allowed tuition expense each year, and the 529 plan earns an average return of 6%, the $150,000 plan balance started at birth will still be worth approximately $240,000 when college rolls around. For the 2022-2023 school year according to CNBC the average cost of tuition, room and board for one year at a public university for an in-state student was approximately $23,250; increasing at a rate of approximately 5%. This means that in 18 years, annual expense at a public university could grow to be more than $55,950 ($225,000+ for four years).
Many grandparents considering gifting to a 529 plan wonder what happens in the scenario where funds remain after all educational expenses have been paid. Fortunately, the 529 plan beneficiary can be changed to another member of the family and even passed through the generations. So remaining funds could become the start of a 529 plan for a great-grandchild. The worst case scenario sees the owner of the plan withdrawing funds to pay for non-educational expenses in which case earnings growth above the original contribution would be taxed as ordinary income plus a 10% penalty rate. Clearly the better scenario is to continue to change beneficiaries until educational expenses have fully depleted the plan.
If you are interested in funding a 529 plan for a child or grandchild reach out to your Parsec financial advisor. You can also do your own research at www.savingforcollege.com. The website even has an information section specifically for grandparents. 529 plans are not the only option for saving for college tuition so talk to your advisor to learn all of your options.
Each state offers its own plan. Much like your 401(k) plan at work, they offer a set list of investments and the assets inside can grow tax free. As of 2023, you can gift up to $17,000 per year per spouse to each child’s account without having to file a gift tax return. You also have the option to do five-year forward gifting, allowing you to lump the next five years gifts into one tax year ($80,500/spouse). However, no other gifts can be made during that period. Once the account balance reaches $300,000+ no other contributions can be made. State rules vary. Visit www.savingforcollege.com to review state options for 529 plans.
Some states offer matching contributions or state income tax deductions on your contributions. There are no federal tax benefits on contributions. If withdrawals are made for qualifying expenses, then you will not owe any taxes on the investment gains received. If you take money out for other purposes, you must pay a 10% penalty and income tax on those earnings.
Morningstar publishes a ranking of 529 plans annually. You can participate in any state’s 529 plan, but there may be tax benefits and incentives for participating in your state’s plan. Picking the best plan with lowest fees should be priority.
The passage of the Secure Act expanded 529 plans to now include student loan repayment and support for homeschooling and apprenticeship programs. Approved uses for 529 plan funds now include up to $10,000 of principal or interest for student loan repayment, which can also be used for siblings. Also, funds can be used to pay for fees, books, supplies and equipment for homeschooling and apprenticeship programs as long as the program is certified with the Secretary of Labor.
SECURE Act 2.0 passed late 2022 now allows 529 account owners to roll 529 funds into a Roth IRA for the beneficiary of the account. However, this new freedom comes with several conditions:
- Rollovers are limited to $35,000 in the beneficiary’s life.
- The 529 plan must have been opened for at least 15 years.
- Contributions made within the last five years, and earnings attributable to those contributions, are not eligible to be rolled over.
- Roth IRA contribution limits apply.
There’s an important caveat to that last bullet point. While contribution limits apply, earnings limits do not. Under normal circumstances, an individual with a modified adjusted gross income (MAGI) of $136,000 or a couple with MAGI of $228,000, would not be eligible to make a Roth IRA contribution because of income limitations. However, these limitations don’t apply to a direct rollover from a 529 plan, providing a new avenue for high income earners to get dollars into a Roth IRA.
See our flyer where we created some projections to help you understand what balances you might expect if you save $50, $100, $200 or $300 monthly along with some key takeaways.