Kids change their minds a lot, so it’s understandable that parents may be worried about tying up money in a college savings plan. After all, what if your child decides to drop out of college or drop out? This money could be spent elsewhere.
Now you can worry less. Unused money allocated for education can soon be saved.
“People with untapped college savings will potentially be able to convert those funds into retirement savings instead of withdrawing them and incurring tax penalties,” said Keith Namiot, chief operating officer of Equitable Group Retirement.
What has changed with education savings or 529 plans?
The $1.7 trillion federal omnibus spending package passed late last year includes a provision starting in 2024 that allows up to $35,000 in Roth individual retirement accounts in 529 education savings plans to be tax-free.
Rollovers can begin when the money has been in the 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 allowance for people over 50.
Under current rules, cash balances must remain in the 529 plan and be used for qualified education expenses or withdrawn, and the earnings are subject to a 10% penalty and federal income tax. Sure, you can change the beneficiary to another family member, such as a grandchild, niece or nephew, sister, or yourself, but let’s face it, you probably don’t want to pay for anyone else’s education besides your own. You may not need it now.
“It’s a huge deal,” said John Bergquist, managing member of Lift Financial. “It opens up the opportunity to do something with the money in the background. It will encourage people to invest in 529s, or at least take a closer look at them.”
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How big of a deal is this change?
To illustrate, Derek Pszenny, financial advisor and co-founder of Carolina Wealth Management, divulged some numbers:
- Let’s say you roll over $35,000 for life from a 529 to a Roth IRA before your child graduates from college at age 22. By the time your child reaches 67, retirement age, that amount will increase to $1.6 million. Based on 9% compound annual growth (the S&P 500 has historically returned about 10% annually).
“I was really excited then,” Pszenny said. “Then, now you start thinking about how to squeeze in a few hundred dollars to save.”
In addition, knowing that residual savings can be used to fund their retirement “can be an incentive (for kids) to save for wherever they decide to go to college,” she said.
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Are there other benefits to a 529 education savings plan?
There are two types of 529 plans, or qualified education programs: prepaid and savings.
Both are offered by states, which can vary slightly from state to state, and both allow you to switch plan beneficiaries to another family member if the money isn’t used. However, the savings plan is more popular because of its flexibility, including rolling over a Roth IRA next year.
The main points of each plan are:
- Prepaid plans allows you to pre-pay and lock in tuition at today’s rates at eligible public and private colleges or universities, but typically does not cover other costs such as room and board. They also often require state residency when you apply and may limit enrollment to a certain period of time each year. Many have age or class restrictions on beneficiaries.
- Savings plans does not require state residency, meaning you can save on any state’s plan within the country. However, some states allow you to deduct your contributions from your state income tax (or receive a state tax credit), which may make your local plan the best option for you financially. You can choose your investments, the income will grow tax-deductible, and the income is tax-free when used for qualified educational expenses such as 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 payments.
What is Superfunding and how is it used?
Used primarily by high-income earners and seniors, superfunding allows you to front-load your 529 savings plan by making five years of contributions at once. Contributions count against your annual gift tax exclusion of $16,000 in 2022.
“For people who are concerned about estate planning, this can be a good tool for people,” said Joel Dixon, Vanguard’s head of advisory methodology. “It doesn’t really change the amount you can give annually, 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 popularized superfunding in 2007 when they contributed just $240,000 to a 529 savings plan for their two daughters. The annual gift tax exclusion that year was $12,000, so the parents each contributed $60,000 (5 years x $12,000). ) to each daughter and avoided tax on amounts without entering the lifetime gift tax exemption.
The IRS allows individuals to give away a certain dollar amount during their lifetime without paying a federal gift tax. This is separate from the amount you can exempt from tax each year.
How do I know which one is right for me when each state offers its own plan?
Do your research.
Online tools can help you compare different plans offered by states and review each plan’s fees, investment options, and tax savings. Places to start might be at the College Savings Plans Network, an affiliate of the professional, nonpartisan National Association of State Treasurers, or at the nonprofit College Savings Fund.
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But Dickson offers some guidelines to help families save for college:
- Start early. An early start allows you to benefit from compounded returns on investments.
- See if a 529 plan makes sense for you. Consider their flexibility, tax benefits and benefits of the accounts and what the money can be used for.
- Target savings over time for one-third of the tag price of college expenses. Often times, people pay far less than the advertised college price.
- Be flexible and adapt. As college approaches, see what you need and adjust contributions accordingly.
And remember, “having more flexibility now to use 529 income means a little less worry that contributions will be locked out,” he said. “This should alleviate some of the concerns, especially for parents with young children.”
Medora Lee is the money, markets and personal finance reporter for USA TODAY. You can reach him at email@example.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.