By Jackson Keenan, CFP®, Director of Financial Planning
Last month, I reviewed ways high-income earners can plan for education expenses. One of the preferred methods is a 529 Education Savings Plan. To recap, a 529 plan:
- Allows you to save and invest for a beneficiary’s future qualified higher education expenses.
- Many states offer tax benefits such as deductions or credits for contributions.
- Deposits can be invested and grow tax-free.
I have seen that several of our clients enthusiastically saved, but the student’s needs changed. The student may get a scholarship, attend a lower-cost school, or may not attend higher education at all. Not using your 529 for qualified expenses results in federal taxes for the earnings portion and a 10% penalty. What started as a great way to save for college has now become a burden.
How Can a 529 Plan Lessen the Sting of Taxes and Penalties?
For starters, you can simply change the beneficiary to someone with more need. The old and new beneficiaries must be qualified family members of the same generation.
These include:
Spouse, siblings or step-siblings, son, daughter, stepchild, foster child, adopted child, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, sister-in-law, father or mother or ancestor of either, stepmother, stepfather, aunt, uncle or their spouse, niece, nephew or their spouse, first cousin or their spouse.
Depending on the plan, you could even change it to yourself!
529 Plan Limitations
Starting in 2024, 529s can be transferred to a ROTH IRA without income limitations. Other rules include:
Naming Limitations:
The Roth IRA receiving the funds must be in the name of the beneficiary of the 529 plan.
Timing Limitations:
The 529 plan must have been maintained for 15 years or longer.
529 Contributions must be at least 5 years old.
Funding Limitations:
The annual limit for funding from a 529 plan to a Roth IRA is the IRA contribution limit for the year ($7,000), less any ‘regular’ traditional IRA or Roth IRA contributions that are made for the year.
The maximum lifetime limit for an individual’s lifetime is $35,000.
The child must still have earned income.
The first two options I discussed help to avoid both taxes and penalties. If you take advantage of the below three options, you will have the 10% penalty waived but you still will pay taxes on the gains:
- The beneficiary receives a tax-free scholarship.
- The beneficiary gets educational assistance through a qualifying employer program.
- The beneficiary attends a U.S. Service Academy (Army, Navy, Air Force, Coast Guard, Merchant Marine).
If you decide to save into a 529 plan, I recommend you consider how much will really be needed in the future. Slightly underfunding can save you a lot of headaches in the future.
Citations:
- Details on the SECURE Act 2.0 topic can be found at Senate.gov under the title “SECURE 2.0 Act of 2022.”
- IRS Publication 970 Tax Benefits for Education
A Message From MONTAG Wealth Management
The information provided is for illustration purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action to be taken. These analyses have been produced using data provided by third parties and/or public sources. While the information is believed to be reliable, its accuracy cannot be guaranteed. MONTAG employees do not provide legal or tax advice. For specific legal or tax matters, you should consult with your own legal and/or tax advisors.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
