Sure, you could change the beneficiary to another family member, like a grandchild, niece or nephew, sibling, or even yourself, but let’s face it, maybe you don’t want to pay for anyone else’s education other than your own children. Now, you may not have to.
“This is a huge deal,” said John Bergquist, managing member of Lift Financial. “It opens the possibility on the backend to do something with the money. This will encourage people to invest in 529s or at least look at them more closely.”
How huge of a deal is this change?
To demonstrate, Derek Pszenny, financial adviser and co-founder of Carolina Wealth Management, crunched some numbers:
- Assume you’ve rolled over the lifetime cap of $35,000 from the 529 into the Roth IRA by the time your kid graduates from college at age 22. By the time your kid reaches 67, retirement age, that amount will have grown to $1.6 million, based on 9% annual compound growth (the S&P 500 historically has returned around 10% each year).
“That’s when I got really excited,” Pszenny said. “Then, you start to wonder how to squeeze out a couple hundred dollars in to save now.”
Additionally, knowing that 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.
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 can differ slightly from state to state, and both allow you to change plan beneficiaries to another family member if the money is unused. However, the savings plan is more popular because of 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 today’s rates at eligible public and private colleges or universities but don’t usually cover other expenses, such as room and board. They also often require state residency when you apply and may limit enrollment to a certain period each year. Many have age or grade limits for beneficiaries too.
- Savings plans don’t require state residency, meaning you can save in any state’s plan across the country. However, some states allow you to deduct your contributions from your state income tax (or get a state tax credit), which could 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, grad school, and trade school; books and supplies; technology costs; and even student loan repayments.
What’s superfunding and how is it used?
Superfunding, used mostly by high-net-worth and older people, allows you to front-load your 529 savings plan by putting in five years’ worth of contributions at once. Contributions count toward your annual gift tax exclusion, which was $16,000 in 2022.
“For folks worried about estate planning, it can be a good vehicle for people,” said Joel Dickson, Vanguard’s head of enterprise advice methodology. “It doesn’t really change the amount you can give on an annual basis, but it can get it out of the estate so it’s not subject to estate taxes.”
Former President Barack Obama and his wife made superfunding famous after they contributed a total of $240,000 in 529 savings plans for their two daughters in 2007. That year, the annual gift tax exclusion was $12,000 so each of the parents funded $60,000 (5 years x $12,000) to each daughter and avoided tax on the amounts without dipping into their lifetime gift tax exemptions.
The IRS allows individuals to give away a certain dollar amount over their lifetimes without paying federal gift tax. It’s separate from the amount you can give away annually tax-free.
With every state offering its own plan, how can I know which is right for me?
Do your research.
Online tools can help you compare the various plans states offer and consider each plan’s fees, investment choices and tax savings. Places to start may be at College Savings Plans Network, an affiliate of the professional, nonpartisan National Association of State Treasurers organization, or the not-for-profit College Savings Foundation.
But Dickson offers some rules of thumb to help families get on the path to saving for college:
- Start early. An early start allows you to benefit from compound returns on investments.
- Look at whether 529 plans make sense for you. Consider their flexibility, tax benefits, and benefits of the accounts themselves and what the money can be used for.
- Target savings, over time, for one-third of the sticker price of college expenses. Most of the time, people pay much less than the advertised college cost.
- Be flexible and adjust. As college gets closer, look at what you need and adjust contributions accordingly.
And remember, “now that there is more flexibility to use 529 proceeds means a little less angst that contributions will be locked up,” he said. “This should alleviate some of the concerns, especially for parents with younger children.”
