I’ve been helping families save for college with 529 Plans for about 20 years. A tax-free way to accumulate money for higher education? Sounds like a “no-brainer” to me. People have a multitude of questions, though, and everyone is afraid of having money left over that they would normally have to pay taxes and penalties on. Welcome to today’s column where we’ll address all the ins and outs of preserving that tax-free status.
First off, let’s address what everyone is so afraid of: after saving for years and years, the funds won’t be able to be used and you can’t get to your money. I’m going to make the case today that 99.99999% of people will be able to make tax-free use of those funds, but if you are the one in a thousand that can’t, you need to know the worst-case scenario. You can always get your money, but if it is not spent on IRS-approved educational expenses or the exceptions we’ll talk about here, the worst that will happen is that you will pay ordinary taxes on the earnings of your contributions (not the contributions themselves) and perhaps a 10% penalty. Unfortunate, but not the end of the world.
Most commonly, a 529 Plan owner can use the funds for educational purposes for another beneficiary related to the original beneficiary if they don’t go to school or don’t use the account funds in their entirety. The new beneficiary can be a sibling, parent, step-parent, grandparent, aunt or uncle or first cousin of the original beneficiary. Some people are surprised to find out that the account can remain open and continue to grow until the original beneficiary’s child can use it for qualified educational expenses. Presently, there is no cap on the number of years that a 529 Plan can remain open and available to pay out appropriate funds.
Another great use of remaining 529 Plan funds that was enacted in 2019 with the SECURE Act is the ability to use up to $10,000.00 for the beneficiary to pay off student loan debt plus up to $10,000.00 to pay on the loans of any of the beneficiary’s siblings. What a great graduation gift!
One newer use of 529 Plan monies is for tuition of up to $10,000.00 per year at private K-12 grade schools. There are a few points that need to be made here. First off, the $10,000.00 limit is for tuition only; books, fees, room & board and other miscellaneous costs won’t qualify. Also, you won’t be charged taxes and penalties at the federal level, but not every state recognizes this use of funds and you may get socked with state taxes. Currently, Iowa approves K-12 expenses, but Illinois does not. Also, 529 Plan are first and foremost supposed to address college costs. If you spend down your balances significantly to pay for K-12 costs, the power of long-term compounding gets lost. And never, ever make the decision to send your child to a private K-12 school just because you have a 529 Plan which will help you pay for it. That should be an important family decision that is impacted by values, your children, your particular circumstances and public alternatives that might be available.
In 2024, the new SECURE Act 2.0 began allowing 529 Plan owners to roll over unused 529 Plan assets to a Roth IRA for the beneficiary. This is allowed tax and penalty free. There are a few conditions upon which you need to proceed. First of all, the 529 Plan must have been open at least 15 years and the amount you can roll over in any given year must have both been in the 529 at least 5 years and must not be over the maximum contribution level for the beneficiary’s age in that year. As an example, in 2024, the maximum contribution into a Roth IRA for someone under age 50 is $7,000.00. If Ann owns a 529 Plan for her daughter, Meaghan, into which she contributed $10,000.00 in 2017 and Meaghan has finished her schooling, Ann can roll over $7,000.00 into a Roth IRA for Meaghan during this calendar year. As it stands now, the maximum that can be rolled over into a Roth IRA for the beneficiary is capped at $35,000.00. Again, though, what a great graduation gift!
Lastly, some students will receive full-ride scholarships and will not use their 529 Plans to their full extent. The family can still use the funds for expenses of the original beneficiary like room & board, books, fees and computers. They can also transfer funds to another family member, save them for their own child or open a Roth IRA. Also, though, the family can draw up to the full amount of the scholarship out to use for family expenses or gift to the child (please be mindful of annual gifting amounts!). Taxes will be assessed on the amount withdrawn, but there will be no 10% penalty assessed.
Do you have more questions about saving for college or personal finances in general? I’d love to be of help! Please email [email protected] or call 563-949-4705.
Securities offered through J.W. Cole Financial, Inc. (JWC) Member FINRA/SIPC. Advisory services offered through J.W. Cole Advisors, Inc. (JWCA). Huiskamp Collins Investments, LLC and JWC/JWCA are unaffiliated entities.