With the ever-increasing costs of higher education, state-sponsored 529 plans have quickly become a popular vehicle for saving and investing for these expenses. However, a drawback of these tax-advantaged plans has been what to do with leftover funds should the beneficiary not need them. In this month’s blog post, we will discuss what options are available to those with an unused 529 plan funds, including insight into the exciting new option introduced with the passage of the SECURE 2.0 Act in 2022.
The greatest benefit of a 529 educational savings plan is often realized when funds can be invested and left to accumulate, ideally from the time the child is born until they attend college. This is because while the contributions themselves are not tax-deductible, they are not considered a taxable gift to the beneficiary and the earnings are tax-free when withdrawn and used for qualified educational expenses. However, for planning purposes, the many unknown factors can make determining a target amount for the account difficult.
Many parents and relatives who choose to save and invest in a 529 plan when a child is young may overshoot how much will be needed in the future in an attempt minimize the risk of running out of funds before the child completes their education. Unused funds can remain in the account if the child needs less funding than anticipated; for example, they receive scholarships or other alternative funding, choose to attend a less expensive college, or decide to not attend college at all.
Until recently, 529 plan owners were limited to the following options for unused balances:
1. Withdraw the funds.
Funds can be withdrawn at any time, however generally it will be subject to a 10% penalty and income tax if used for non-qualified expenses.
2. Transfer funds to a different beneficiary.
The beneficiary of a 529 plan can be changed to a family member of the current beneficiary tax- and penalty-free. This can include, but is not limited to, their spouse, siblings, parents, children and grandchildren, or step-relatives and in-laws.
3. Leave the funds in the plan.
Because 529 plan funds do not need to be spent by a specific age, any unused funds can be left in the plan for future use. Qualifying educational expenses can include postgraduate courses and specialized certifications that many established professionals find beneficial, as well as vocational training for practical skills.
4. Repay student loans.
Up to $10,000 from a 529 plan can be used towards federal or private student loan repayment. This option is considered a qualified expense in regard to the 10% federal penalty, however individual states may classify it as non-qualified and thus subject to state income tax.
The passage of the SECURE 2.0 Act by Congress at the end of 2022 introduced an additional option for 529 plan account holders that has generated a lot of interest: 529 plan funds can now be rolled into a Roth IRA.
Beginning in 2024, 529 plan beneficiaries will be allowed to use leftover 529 plan funds to boost their retirement savings. Parents and relatives of plan beneficiaries may appreciate being able to have the plan continue to provide value to the beneficiary once school is paid for. However, there are several rules to navigate:
- The 529 plan beneficiary and the owner of the Roth IRA must be the same
- The 529 plan must be open for at least 15 years
- Any contributions (and subsequent earnings) made in the past 5 years are not eligible to be rolled over
- Any amount rolled over is subject to the annual aggregate IRA contribution limit
- The 2024 annual total contribution limit to one’s traditional and Roth IRAs is $7,000 (not including the $1,000 catch-up provision if 50+)
- Contributions and 529 plan rollovers across all IRAs cannot exceed the annual limit
- Any amount rolled over is also subject to the earned income limit
- To contribute to a Roth IRA, one must have earned income for the year
- An individual’s annual contribution limit is the lesser of $7,000 or their earned income for the year
- There is a lifetime rollover maximum of $35,000
- The annual income limitations that normally apply to Roth IRA account holders do not apply to 529 plan rollovers
- Eligibility to contribute to a Roth IRA is typically phased out when income reaches a given threshold ($146,000 for singles and $230,000 for those married filing jointly in 2024), however this is not applicable when rolling funds over from a 529 plan
- This can then allow a beneficiary to contribute to a Roth IRA when they otherwise would not be eligible to do so
- The funds must be rolled over directly, from plan-to-plan or trustee-to-trustee
While future legislation may further clarify or modify this provision, as it stands now, it is an excellent option to have available to 529 plan owners.
If you are interested in discussing ways to maximize the benefits of a 529 educational plan, whether your loved one is 18 months or on the cusp of adulthood, your Vision Capital Client Relationship Manager is eager to provide guidance and discuss the options available to you and your loved ones.