Kids change their minds often, so it’s understandable that parents can be nervous to put money into a college savings plan. After all, what if your child decides to drop out of college or drop out? That money could have been spent elsewhere.
You can worry less now. This unused money for education can be saved soon.
“It’s possible that people with unused college savings could roll that money into retirement savings rather than having to withdraw it and incur tax penalties,” said Keith Namiot, COO of Equitable Group Retirement.
What has changed with tuition savings, or 529 plans?
The sweeping $1.7 trillion federal spending package passed late last year includes a provision that allows tax-free amounts of up to $35,000 in 529 school savings plans to pass into individual Roth retirement accounts starting in 2024.
Rollovers can only begin if the money has been in 529 for at least 15 years. The amount is also subject to annual Roth IRA limits. The contribution limit for 2024 is set at $6,500, with an additional $1,000 compensation allowance for people over 50.
Under current rules, remaining funds must remain in the 529 plan and be used for qualified education expenses or else be withdrawn and a 10% penalty and federal income tax imposed on the earnings. Sure, you could change the beneficiary to another family member, like a grandchild, niece, nephew, sibling, or even yourself, but let’s face it, you probably don’t want to pay for anyone else’s education other than your kids. Now, you may not have to.
“This is a huge deal,” said John Bergquist, managing director at Lift Financial. “It opens up the possibility on the backend of doing something with the money. This will encourage people to invest in 529 or at least look at it more closely.”
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What is the deal size of this change?
To illustrate, Derek Bzeny, financial advisor and co-founder of Carolina Wealth Management, broke down some numbers:
- Suppose you roll the lifetime cap of $35,000 from a 529 into a Roth IRA by the time your son graduates from college at age 22. By the time your child reaches 67, the retirement age, that amount will have increased to $1.6 million, Based on a compound annual growth of 9% (the S&P 500 has historically returned about 10% each year).
“That’s when I got really excited,” Paszini said. “Then, you start wondering how you can squeeze in a few hundred dollars to save now.”
In addition, knowing that remaining savings can be used to fund their retirement “can be an incentive (for kids) to be frugal about where they decide to go for college,” he said.
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Are There Other Benefits of a 529 Education Savings Plan?
There are two types of 529 plans, or qualifying education programs: prepaid and savings.
Both are offered by states so they can vary slightly from state to state, and both allow you to change plan beneficiaries to another family member if the funds are not used. However, the savings plan is more popular because of its flexibility, including next year’s Roth IRA renewal.
Here are the main points of each plan:
- Prepaid plans They allow you to prepay and fix tuition at today’s rates at eligible public and private colleges or universities but usually do not cover other expenses, such as room and board. They also often require state residency when applying and may limit enrollment to a certain period each year. Many of them have age limits or grades for recipients, too.
- savings plans It doesn’t require state residency, which means you can save on any state’s plan across the country. However, some states allow you to deduct your contributions from state income tax (or take a state tax credit), which may make your local plan your best option financially. You choose your investments, earnings grow with tax deferment and withdrawals are tax deductible when used for qualified education expenses such as tuition and fees for K-12 (up to $10,000 annually per beneficiary), college, graduate school, and trade school; Books and supplies. Technology costs and even student loan repayments.
What is overfunding and how is it used?
Used by seniors and seniors, Ultra Financing allows you to preload your 529 savings plan by making five years’ worth of contributions in one go. Contributions count toward the annual gift tax exclusion, which was $16,000 in 2022.
“For people who are worried about estate planning, it can be a good way for people,” said Joel Dixon, head of corporate advice methodology at Vanguard. “It doesn’t really change the amount you can give on an annual basis, but it can take it out of the estate so it’s not subject to estate taxes.”
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Former President Barack Obama and his wife became famous for their superior finances after they contributed a total of $240,000 to a 529 savings plan for their two daughters in 2007. That year, the annual gift tax exemption was $12,000, so each parent funded $60,000 (5 years x $12,000) per daughter and avoid taxes on amounts without indulging in lifetime gift tax breaks.
The IRS allows individuals to give away a certain amount of dollars over the course of their lifetime without paying the federal gift tax. It’s separate from the tax-deductible amount you can donate annually.
With each state offering its own plan, how do I know what is right for me?
Do your research.
Online tools can help you compare different plans offered by states and look at each plan’s fees, investment options, and tax savings. May be places to start at College savings plans networkan affiliate of a nonpartisan professional association of the National Association of State Treasurers, or a not-for-profit organization College Savings Foundation.
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But Dixon offers some ground rules to help families get on the road to saving for college:
- I started early. An early start allows you to take advantage of compound returns on investments.
- See if a 529 plan makes sense for you. Consider their flexibility, tax advantages, the benefits of the accounts themselves, and what the money can be used for.
- Aim for savings, over time, of one-third of the sticker price for college expenses. Most of the time, people pay much less than the advertised cost of college.
- Be flexible and adjust. As college approaches, look at what you need and adjust contributions accordingly.
And remember, “Now that there’s more flexibility in using 529 proceeds that means less worry that contributions will be frozen,” he said. “This should ease some concerns, especially for parents with younger children.”
Medora Lee is USA TODAY’s money, markets and personal finance correspondent. Reach out to her at firstname.lastname@example.org and sign up for her free Daily Money newsletter for personal financial advice and business news every Monday through Friday morning.