Is the 529 Plan worth the weight in gold?
There are mixed opinions out there.
Everyone has a different reality; it's hard to determine a fit for everyone.
They are great if you have secured your financial future and can give annual gift amounts to family members.
A plan can even start with you as a beneficiary.
Let's review some pros and cons to see if it works for you.
Benefits of 529 Plans
The biggest draw to these plans is the tax-free growth on the investment when used for educational expenses.
If you withdraw funds to pay for qualified educational expenses (like tuition, fees, books, and certain room and board costs), you won't have to pay any federal income tax on that money.
This can be used for K-12 private school tuition, college, trade school, and apprenticeships.
Many states waive their income taxes on these withdrawals as well.
529 Plans allow you to save a substantial amount of money over the years for a child’s education.
You can gift up to $18,000 in 2024 for each person you set an account up for.
For example, if you and your spouse have a 529 for Johnny, you each can contribute $18k, for a total of $36,000 for that year.
You can use a 5-year election to gift a lump sum of $90,000 upfront ($180,000 for couples filing jointly) without incurring taxes.
This is 5 years forward.
Now, this is powerful because it removes it from your estate.
If there are young kids, instead of giving them money, place them in their 529.
These plans let you change the beneficiaries, so if you set one up for a child and they don't use it, you can change it for their children.
Therefore, you can gift and allow multi-generational use of the funds.
Most states have great asset protection laws that may protect 529 plans; fancy trusts may not be needed.
Disadvantages of 529 Plans
There are limited investment options; yes, you must choose Wall Street here.
You typically can choose from a pre-defined list of mutual funds or portfolios.
Also, management fees associated with these funds can eat into returns.
If funds are used for anything other than qualified educational expenses, you may owe income tax plus a 10% penalty.
Money in a 529 plan can slightly decrease a student's financial aid eligibility.
Secure 2.0 Roth IRA Rollover Benefits
Starting in 2024, beneficiaries can roll over their 529 funds into a Roth IRA tax and penalty-free.
Still, there are some key points to pay attention to.
- The plan must be open for 15 years to avoid taxes and penalties on rollovers. If the beneficiary changes, the clock resets.
- 529 contributions within the last 5 years, including earnings, cannot be rolled over from a 529 plan.
- Rollovers are exempt from Roth IRA income limits. The beneficiary must have earned income at least equal to the rollover amount. Annual rollover limits to a Roth IRA are capped at the Roth IRA's annual contribution limit, $7,000 in 2024.
- Rollovers reduce the allowable contribution to an IRA or Roth IRA for that year. If the maximum contribution has already been made to an IRA or Roth IRA, 529 rollovers aren't possible for that year.
- Per beneficiary, the lifetime limit for 529 to Roth IRA rollovers is $35,000.
- Post-rollover funds cannot be returned to a 529 account.
- Rollovers must be direct transfers, plan-to-plan (trustee to trustee), or trustee-to-trustee, without intermediary checks.
Who Should Consider a 529?
Most people at any age with excess capital should entertain a plan.
For generations, the benefits of an education fund can dramatically change a family's direction.
The tax benefits and asset protection are just as important.
The IRA rollover then compounds this.
Considerations
Don't limit yourself to your own state’s plan.
Check if your state allows for a tax deduction on the contributions first.
Explore options nationwide to find the best fees and investment decisions.
Decide if any family members will ever need private school or college.
Last, have you used that beneficiary's annual gift exclusion amount yet?
Conclusion
I set up plans for my two boys years ago.
I contributed to their plan for a few years at an early age.
This allows years ahead to compound after I stop contributing.
I hope they don’t use it, but they can roll over a portion to ROTH IRA and use the balance for their kids.
Hope this helps you decide.
