Unlocking Bright Futures: A Useful Tool in Education Planning

As another school year comes to an end, I want to make sure you are up to date on the latest educational savings opportunities. Education remains a vital stepping stone towards an individual’s personal and professional development and with the rising costs of college tuition, families and individuals need reliable financial tools to save for educational expenses. One such tool that has gained significant popularity is the 529 account. This educational savings plan has enabled individuals to plan ahead and secure the financial resources necessary for pursuing higher education. And thanks to the Secure Act 2.0, there has recently been an added benefit that makes 529 accounts even more attractive.

What is a 529 account?

The 529 account is an education savings plan that allows parents, grandparents, friends, or really anyone to put aside money that will be used to fund a student’s education. However, these dollars can only go toward qualified education expenses, such as tuition, books, computers, room and board, and other related costs at eligible educational institutions.

What are the benefits?

The main benefit of a 529 plan is the tax advantages. Contributions to these accounts are made with after-tax dollars, which means they are not tax deductible at the federal level, but some states (like Pennsylvania) offer state tax deductions. Either way, the earnings on the investments grow tax-free and qualified withdrawals are also distributed tax-free, which can significantly enhance the growth potential of the savings over time.

The 529 plan also provides flexibility when choosing beneficiaries. It allows the account owners to change the beneficiary to another eligible family member without incurring penalties or taxes. At Stewardship Advisors, we have found this to be an effective way to transfer wealth and strategically plan around Financial Aid when there is more than one child in a family expecting to pursue higher education. When it comes to Financial Aid, 529 accounts are generally treated favorably. The assets held in a parent-owned 529 plan are assessed at a lower rate (up to 5.64% according to the College Investor) on the FAFSA. If the assets were held in a custodial account, like a UGMA/UTMA, they would be treated as student-owned, and the financial aid package would be assessed at 20% instead. That’s a sizable difference and something we help our clients avoid if possible.

Secure Act 2.0: Converting 529 Funds to Your Roth IRA

So, what is this new added benefit to the 529 account that resulted from the Secure Act 2.0? Beginning in 2024, a 529 plan beneficiary will have the ability to roll over up to $35,000 over the course of their lifetime to their own Roth IRA without paying taxes or penalties. Rollovers are subject to the Roth IRA annual contribution limits, which are currently $6,500 and can only occur after the 529 account has been open for more than 15 years.

In the past, the frustrating part about managing a 529 plan was how to use the money if the beneficiary decided to not go to college. The 529 funds had to be used on the qualified education expenses listed above, and if money was withdrawn for any other purpose, it was subject to a 10% penalty. As a result, the original beneficiary would sometimes be changed to another member of the family or even to future children of the original beneficiary, just to avoid the penalties.

Now, parents will not feel as if they are getting penalized if their children do not pursue higher education. Instead, this can kick start retirement savings for your children, so they can have a more stable financial future. If left untouched, $35,000 in a retirement account can go a long way with compounded returns over 40 years. Thanks to the Roth IRA rollover provision, the 529 plan has become a very useful tool to provide long-term financial security for your loved ones.

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