A 529 is a great way to save money for your child’s or grandchild’s higher education, but, what happens if they choose not to go to college? Secure Act 2.0 has some interesting new laws regarding 529 accounts and Roth IRA’s.
What Are 529 Accounts and How Do They Work?
For the past 40 years, the tuition costs for education have been consistently increasing at rates that are much higher than inflation. As early as the late 80s, states began to develop different plans to incentivize parents to save for the educational expenses of their children. In 1996, Congress pressed for federal tax relief for educational savings and Section 529 of the Internal Revenue Code was created. Shortly thereafter, 30 different states created “Section 529 Savings Plans” for their residents, and any US resident can create a 529 savings plan in any state.
This educational savings tool provides a savings account and an investment opportunity, and has a single declared beneficiary. The beneficiary can be changed by the account owner from one child to another, or from a child to a grandchild. The money accumulated in the 529 savings account can be used for eligible educational expenses tax free, and contributions to the account are tax deductible. This is a win-win for the owner/contributor and the beneficiary. Funds used for ineligible expenses are not only taxed, but subject to a 10% penalty on top of the taxes. Ouch.
What if My Child Doesn’t Go to College?
Many people do not use 529s (or do not make maximum contributions) because they are not positive what their 5 year old child will do at age 20 or 25. This is a valid concern, and there are funds that remain stranded or forgotten because the beneficiary did not choose to attend a college or university. Perhaps a child chooses to attend a trade school, and the expenses are significantly less than the amount set aside in the 529 account. What then?
Honestly, the options are limited at this time, and primarily consist of transferring the money to a new beneficiary or withdrawing the money and paying the taxes and penalties. Because of the SECURE 2.0 Act, that is about to change.
New 529 Provisions from SECURE 2.0 Act
The SECURE 2.0 Act enhances retirement savings options and provides for some financial relief to persons who are willing to set aside money for retirement and emergencies. One retirement based provision will allow beneficiaries of Section 529 savings accounts to roll their educational savings directly into their Roth IRA retirement accounts. There are several restrictions and rules, including:
- A $35,000 lifetime rollover limit
- Annual contribution limits
- Can only be rolled over for the beneficiary (not the owner)
- Account must be open for 15 years before becoming eligible for rollover
Even with limitations, this new legislation greatly alleviates the primary concern of the 529 account, ensuring that a child’s money is not going to get stuck there or heavily taxed and penalized.
Conclusion: The 529, Roth IRA and Time Value of Money
There are still many areas of ambiguity in this legislation that will be clarified over the coming weeks and months. We are estate planning attorneys, and we do not provide investment advice. We are excited about the possibilities that this legislation can open up for smart investment and retirement savings opportunities. Never underestimate the time value of money. When funds are successfully rolled over into a Roth IRA in a beneficiary’s 20s, those funds will have up to 40 years to grow. If you have children or grandchildren, we encourage you to consult with a qualified financial advisor to see if contributions to a 529 account could provide valuable tax benefits to you and valuable educational and retirement savings for your beneficiaries.
To listen to our full podcast about 529 and SECURE 2.0, click here.