Are you using a 529 savings plan to help fund your children’s future higher education expenses? According to the Education Data Initiative, only about 30 percent of households are currently utilizing these accounts. This relatively low participation rate may be due to a variety of reasons – one of them most likely being the fees imposed when funds are withdrawn for purposes other than higher education.
Thankfully, that’s about to change. Starting in 2024, a new rule will be added to 529 savings plans that will make them an even better deal for both parents and their young adult children. Here’s what you’ll need to know.
What Is a 529 Savings Plan?
In case you’re not familiar with this financial tool, a 529 plan is a U.S. tax-advantaged investment account designed to help families save and pay for their children to go to post-secondary school. This might be a college, university, trade school, or any other qualifying program.
Each child gets their own plan. While parents are considered the account owner, the children are designated as “beneficiaries”. Contributions are made on their behalf by their parents or outside parties such as grandparents, aunts, uncles, etc.
Similar to a Roth IRA, money going into the account comes from after-tax income. However many states allow parents to deduct contributions from their taxable income – reducing how much they owe to the state treasury for the year.
Once you put your capital into the 529 account, it gets invested for growth. You may choose from a menu of investments, or the plan may be managed by a fund manager (depending on the platform you choose to use).
Typically with actively managed funds, the asset allocation will be aggressive for younger beneficiaries and gradually shift to more conservative as they get closer to graduating high school. Just like a retirement account, the idea is that these contributions will experience compound growth and generate earnings beyond what you’d receive from a regular savings account.
Once the children are ready for a higher education program, the money inside the 529 plan may be used for any qualified expense, including:
- Tuition
- Books
- Fees
- Room and board
- Equipment and technology (such as a laptop)
- Etc.
Parents will keep track of these withdrawals and report them on their federal income tax filing.
Changes Coming to 529 Plans in 2024
While there are clearly many benefits to using a 529 plan, one of the cons is what happens when a withdrawal is “unqualified” or used for something other than a higher education expense. This typically applies to children who don’t end up pursuing a post-secondary education program or need the money for some other purpose (such as an emergency).
In these situations, the account owner will have to pay both taxes as well as a 10% penalty tax. Up until now, the only way around this was to transfer unused balances to another beneficiary such as a sibling or family member.
Thankfully, that’s about to change in 2024. Because of a new bill that was passed in late 2022 called Secure 2.0, unused 529 plan funds can now be transferred to a beneficiary’s Roth IRA account. This is under the following conditions:
- The beneficiary of the 529 must be the owner of the Roth IRA
- The 529 account must have been opened 15 years ago or later
- The Roth IRA account owner must have includible compensation at least equal to the amount of the rollover
- The rollover amount is capped at a lifetime amount of $35,000
- Contributions made to the 529 in the past year are ineligible for a tax-free transfer
- Rollover amounts count towards the Roth IRA account owner contribution cap
Why You Should Use a 529 Savings Plan
529 plans can help families to get a major jump start on paying for higher education. The funds can be used at a wide variety of institutions for a multitude of various expenses.
Just like a retirement plan, the dual benefit of compounding returns and tax-free growth will help parents to build their savings. Starting out when their child is born gives them 18 years of investment opportunity.
Moreover, the more money that can be saved to cover these expenses, the less reliant your children will be on student loans. In theory, if you save enough every month and your child qualifies for a handful of scholarships, they may not need to borrow any money at all. By starting out adulthood without any major debt, you’ll enable your children to pursue life without being financially burdened.
How to Set Up a 529 Savings Plan
If a 529 savings plan sounds like something you’d like to use, especially now that you’ll be able to roll over unused funds into a Roth IRA for your children, then you’ll be happy to learn that starting a plan is fairly simple.
Begin by typing your state plus 529 plan into your favorite web browser. The search engine will take you to the official platform hosting your state’s plan. Alternatively, you can also choose to open a 529 with a full-service brokerage such as Vanguard or Fidelity.
Please keep in mind that you’re allowed to open 529 plans in states other than your own. However, you won’t likely get the tax benefits that come with using the one in the specific state where you live.
Once the account has been established, the next step is to focus on what every good account needs – contributions! This is where you’ll want to elect to transfer a certain amount each month: $50, $100, $250, etc. Obviously, the more you can save, the more you’ll have set aside for your children’s education when the time comes.
Between your own retirement, emergency savings, and a 529 plan, it can be challenging to divide up your discretionary income among these competing priorities. This is why it’s so important to budget your money and keep track of your spending using a helpful app like Buxfer.
When you know what you’re spending your money on, you’ll be able to do a better job cutting out excess purchases and staying disciplined with your spending plan. That way you’ll be able to devote your finances to what’s truly important. And now that the rules for 529 plans allow for Roths, you’ll be able to help your children’s financial future too.
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