Rolling a 529 Into Something Else

Parents often turn to 529 plans as an invaluable way of providing their children with college funds, but what happens if your child opts out or you need to change the beneficiary?

With new rules in effect, this process has become much simpler: unused 529 funds may now be converted into Roth IRA accounts of beneficiaries.

Taxes

A 529 plan is a tax-advantaged education investment account. Parents frequently use them as a savings vehicle. Families can currently invest up to $17,500 without incurring federal gift taxes for any beneficiary; contributions exceeding this threshold could trigger the IRS’ accelerated gift rule.

These accounts are sponsored by state governments in partnership with financial firms. Their funds grow tax-deferred, and withdrawals made to pay for qualified education expenses, such as tuition, fees, books and computer equipment are tax-free if used to fund them – such as tuition costs for an undergraduate degree program or registered apprenticeship programs.

Alternatively, the account owner could roll their funds into a Roth IRA for themselves or, starting in 2024, transfer them to another younger relative if they meet certain criteria. Another option may be cashing out their account but doing so would incur a 10% penalty fee.

Scholarships

Saving for college should certainly be a top financial priority, but that shouldn’t be your only goal. Instead, prioritize paying down consumer debt such as credit card balances, student loans and car payments; setting aside emergency savings that cover 3-6 months of expenses; and investing 15% of your income into retirement accounts like 401(k)s and Roth IRAs.

While it might be tempting to take out money from your 529 fund for non-qualified expenses, taking a distribution could expose you to income taxes and an additional 10% penalty.

Instead, you have the option to transfer the money to another beneficiary or plan. There is one exception; only one transfer per 12-month period can take place and must involve an eligible plan that offers state tax deduction. A fiduciary financial advisor can help determine whether this approach makes sense for you and help guide you accordingly.

Graduation

Saving in a 529 plan can give you a tax break for investing in education. When withdrawing the money for qualified educational expenses, both federal and state income taxes (and in many cases even your local state’s income taxes) will be waived.

But there are a few restrictions: you may only use withdrawals to cover tuition and fees at public, private or religious elementary and secondary schools as well as certain costs such as course-related equipment or room and board expenses. Any withdrawals used for any other purposes will incur a 10% penalty plus income tax.

529 accounts don’t require distribution on any specific date; so if your child decides against going to college, you could use its funds for another purpose like paying tuition costs of younger siblings, graduate-school studies such as law or accounting masters degrees or rolling over into a Roth IRA for retirement savings tax-deferred.

Retirement

529 plans allow parents to select from a wide selection of stock and bond mutual funds, age-based portfolios that gradually transition away from riskier holdings as your child ages, as well as state plans offering prepayment for tuition services at current rates.

If your child does not use all of the funds set aside for education, you can withdraw it without incurring tax penalties if used towards qualifying expenses such as college, trade school or community college attendance. Alternatively, transfer it to another beneficiary such as spouse, sibling or even yourself if returning to graduate studies is your goal.

Starting in 2024, a new provision of the SECURE Act 2.0 will enable you to move unused 529 funds directly into a Roth IRA up to the annual limit. An experienced financial professional can assist with assessing this option and selecting the one most suited to your personal situation.


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