Children often change their minds, so it’s understandable that parents are nervous about putting money aside in a college savings plan. After all, what if your child decides to skip college or drop out? This money could have been spent elsewhere.
You can worry less now. This unused money intended for education can soon be recovered.
“People with unused college savings will potentially be able to turn these funds into retirement savings rather than having to withdraw them and incur tax penalties,” said Keith Namiot, chief operating officer of financial services provider Equitable Group. Withdrawal.
What has changed with tuition savings plans, or 529 plans?
The $1.7 trillion federal omnibus spending program passed late last year includes a provision that allows tax-free transfers of up to $35,000 into 529 tuition savings plans to individual Roth retirement accounts from 2024.
Rollovers can only begin if the money has been in a 529 for at least 15 years. The amount is also subject to Roth IRA annual limits. The contribution limit for 2024 is set at $6,500, with an additional catch-up allowance of $1,000 for people over 50.
Under current rules, the remaining money must stay in a 529 plan and be used for eligible educational expenses or else be withdrawn and charged a 10% penalty and federal income tax on the earnings. Sure, you can change the beneficiary to another family member, like a grandchild, niece or nephew, brother, or even yourself, but let’s face it, maybe you don’t want to pay education of someone other than your own children. Now you may not have to.
“It’s a huge deal,” said John Bergquist, managing member of Lift Financial. “It opens up the possibility for the background to do something with the money. It will encourage people to invest in the 529s or at least take a closer look.
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How huge is this change?
To demonstrate this, Derek Pszenny, financial advisor and co-founder of Carolina Wealth Management, calculated some figures:
- Let’s say you’ve exceeded the $35,000 lifetime cap on the 529 Roth IRA by the time your child graduates from college at age 22. By the time your child reaches retirement age 67, that amount will have grown to $1.6 million, based on compound annual growth of 9% (the S&P 500 has historically returned about 10% every year).
“That’s when I got really excited,” Pszenny said. “Then you start wondering how to squeeze a few hundred dollars to save now.”
Plus, knowing leftover savings can be used to fund their retirement “can be an incentive (for kids) to be frugal about where they decide to go to college,” he said. declared.
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Are there other benefits to 529 Education Savings Plans?
Yes.
There are two types of 529 plans, or qualified tuition programs: prepaid and savings.
Both are offered by states, so they may differ slightly from state to state, and both allow you to change the beneficiaries of the plan to another family member if the money is not not used. However, the savings plan is more popular due to its flexibility, including the Roth IRA rollover next year.
Here are the key points of each plan:
- Prepaid plans allow you to prepay and lock in tuition at current rates at eligible public and private colleges or universities, but generally don’t cover other expenses, such as room and board. They also often require state residency when you apply and may limit enrollment to a certain time period each year. Many also have age or grade limits for recipients.
- Savings plans don’t require in-state residency, which means you can save in the plan for any state across the country. However, some states allow you to deduct your contributions from your income tax (or get a state tax credit), which might make your local plan the best option for you financially. You can choose your investments, earnings will grow tax-deferred, and withdrawals are tax-free when used for qualified education expenses like tuition and fees for K-12 (up to $10,000 per year per beneficiary), college, graduate school and trade school; books and supplies; technology costs; and even student loan repayments.
What is superfunding and how is it used?
Superfunding, used primarily by the wealthy and the elderly, allows you to pre-load your 529 savings plan by making five years of contributions at a time. Contributions count towards your annual gift tax exclusion, which was $16,000 in 2022.
“For people concerned about estate planning, this can be a good fit for people,” said Joel Dickson, head of business consulting 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 inheritance tax.”
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Former President Barack Obama and his wife made superfunding famous after contributing a total of $240,000 to 529 savings plans for their two daughters in 2007. That year, the annual tax exclusion on donations were $12,000, so each parent funded $60,000 (5 years x $12,000). ) to each daughter and avoided tax on the amounts without tapping into their lifetime tax exemptions.
The IRS allows individuals to give a certain amount over their lifetime without paying federal gift tax. It is separate from the amount you can donate annually tax-free.
Each state offers its own plan, how do I know which one is best for me?
Do your research.
Online tools can help you compare different plans offered by states and consider each plan’s fees, investment choices, and tax savings. Starting points can be the College Savings Plans Network, an affiliate of the professional, nonpartisan organization National Association of State Treasurers, or the nonprofit College Savings Foundation.
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But Dickson offers a few rules of thumb to help families get started on the path to saving for college:
- Start early. An early start allows you to enjoy compound returns on your investments.
- See if 529 plans are right for you. Consider their flexibility, tax advantages and benefits of the accounts themselves and what the money can be used for.
- Target savings, over time, for one-third of the listed price of university expenses. Most of the time, people pay much less than the advertised cost of college.
- Be flexible and adapt. As college gets closer, review what you need and adjust contributions accordingly.
And remember, “now that there’s more flexibility to use 529’s product, it means a little less anxiety about contributions being blocked,” he said. “That should alleviate some of the worries, especially for parents of young children.”
Medora Lee is a money, markets and personal finance reporter at USA TODAY. You can reach her at mjlee@usatoday.com and sign up for our free Daily Money newsletter for personal finance tips and business news Monday through Friday mornings.
