By Theresa Cagle Fry, Senior Vice President and Manager IRAs, Retirement & Education Planning
Memorial Day is right around the corner. It is a day on which we honor those men and women who died while serving in the U.S. military. It has also come to signify the unofficial start to summer. But this year it is also May 29 and National 529 Day – a day for financial planning which serves as a reminder that it has never been easier to save for a child’s education using 529 education savings plans.
529 education savings plans offer a unique way of saving for education in a tax-advantaged manner. 529 plans are named after the Internal Revenue Code – Section 529 – that created them. They can be an excellent way to provide income tax-free benefits for qualified education expenses. Contributions (gifts) of $17,000 per student/beneficiary per year can be made, or alternatively, you can use a special advanced funding rule that allows up to five years of annual gifts to be made at one time. This increases the contribution amount to $85,000[i]. For married couples, both spouses can make gifts to the same student/beneficiary doubling the amounts to $34,000 and $170,000.
Although there is no federal income tax deduction available for contributions made to a 529 education savings plan, investments grow tax deferred and if used for qualified education expenses, the withdrawals will be income tax free[ii]. 529 savings plans are sponsored by states, and many will provide the contributor with a state income tax deduction or credit. For states that offer an income tax deduction or credit, the tax benefit is typically contingent upon the contribution being made to the 529 plan that is sponsored by the state you reside in, although a few exceptions apply.
If you have avoided funding a 529 savings plan for your child or grandchild for fear of them not going to college, or if you have concerns about them having leftover savings after college, 529 education savings plans are more flexible than ever before. Over the years, 529 savings plan benefits have been expanded. They are no longer exclusively for use with colleges and universities.
Tax-free benefits from a 529 plan can be used for K-12 tuition (up to $10,000 per year), for trade schools or apprenticeship programs after high school, and for repayment of student loan debt (up to $10,000) for the student or siblings of the student[iii]. You also have the flexibility to change a beneficiary, income tax free, to another eligible family member. For example, you could move all or part of the savings from your oldest child to a younger child or keep them in the plan and in the future change the beneficiary to the current beneficiary’s children. Beginning next year, long-term unused 529 education savings plan balances can also be moved tax free to a Roth IRA for the 529 plan beneficiary to be used for future retirement income.
This new 529 savings plan to Roth IRA feature will be available Jan. 1, 2024. To be eligible to transfer your 529 savings plan balances to a Roth IRA:
- The amount transferred must be from a 529 savings plan that has been available for at least 15 years and cannot represent any contributions or earnings from the prior five years.
- The Roth IRA beneficiary must have earned income, although the typical Roth IRA modified adjusted gross income limits do not apply.
- The amount transferred to the Roth IRA cannot exceed the annual Roth IRA contribution limit (for 2023 this amount is $6,500).
- The total amount transferred during the 529 savings plan beneficiary’s lifetime cannot exceed $35,000.
If you are planning to help with your child’s or grandchild’s education costs, the tax advantages and flexibility of a 529 savings plan make it a more attractive alternative than using your personal or retirement savings. When you consider the average one-year undergraduate cost for the 2022-2023 academic year for tuition, fees, room, and board for attending a 4-year public out-of-state college was $40,550 and $23,250 for an in-state 4-year public school, there is no better time to create a savings plan for your loved one’s education. Contact a Benjamin F. Edwards financial advisor today for more information about 529 education savings plans.
Benjamin F. Edwards does not provide legal or tax advice, therefore it is also important to consult with your legal and tax professionals for additional guidance tailored to your specific situation.
[i] When making the election for advanced 5-year gifting to fund a 529 education savings plan, no additional gifts can be made to the student/beneficiary during the 5-year period if the advanced gifting is for five times the annual gift limit. Otherwise, the gift will be prorated over five years equally.
[ii] Withdrawals that are not used for qualified education expenses typically result in federal income taxes and a 10% penalty on the earnings portion of the withdrawal. Some exceptions to the penalty apply. Non-qualified withdrawals can also result in a recapture of state income tax benefits previously received.
[iii] These uses of 529 savings plans, although recognized as qualified tax-free distributions for federal income tax purposes, may not be considered qualified distributions for your state income tax return. State non-qualified withdrawals can result in a recapture of the previously provided state tax deduction or credit.