529 Plans Get A Major Upgrade

The Secure Act 2.0 passed in December 2022 introduced a number of changes.  One of the biggest is an upgrade to 529 plans.  This change impacts how you should think about saving for those expenses for your children or grandchildren.  It is even more exciting than Rothificaiton.

Watch Now:  529 Plans Get a Big Upgrade

Timeline

• 0:00 - Intro, Disclaimer, Welcome
• 0:43 - 529 plans - the basics
• 3:22 - The big problem with 529 plans and how to solve it.
• 4:55 - A Huge Upgrade
• 7:37 - This changes how you think about helping your kids or grandkids.
• 8:57 - Student loan payments and saving for retirement.
• 9:43 - The long-term Roth value
• 10:42 - Outro

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What Are 529 Plans?

In 1996, the same legislation that created Roth IRAs also introduced 529 plans.  These accounts allow for tax-deferred accumulation of funds for qualified educational expenses.  When withdrawn for those education-related costs, there were no taxes due on any of the growth in the account.  In addition, many states will offer a state income tax deduction for 529 plan contributions.  

The list of qualified education expenses is extensive.  It includes tuition, room and board, the purchase of a computer, and in some cases rent.  A few years ago, the list of qualified expenses expanded to allow tuition for primary and secondary schools and up to $10,000 that could be applied towards student loans.

This created an attractive way to save for college, but there is a tradeoff.  Distributions not made for qualified expenses can be taxed and penalized.  When the funds are withdrawn for something else, there will be taxes due on the growth (at ordinary income rates) and a 10% penalty.  This created a dilemma of sorts.

Not Everyone Goes to College

College isn't the right path for everyone.  And saving money with a singular purpose can be problematic for some.  Many times when these accounts are established, it is impossible to know if the child is going to pursue a college education.  Money saved in a 529 plan essentially gets "stuck."  Taking it out results in taxes and penalties.  Beneficiaries can be changed, but that can also create some problems. 

If parents or grandparents wanted flexibility in the use of the money, a 529 plan was not a good fit.  There are other choices (such as individual or joint accounts or UGMA accounts) but they don't offer the same tax benefits.

Upgrading 529 Plans

When passed in December 2022, the Secure Act 2.0 introduced a major upgrade to 529 plans.  Now, a 529 plan which has been open for at least 15 years can now be converted to a Roth IRA for the beneficiary of the account.  This means if the child doesn't go to college or earns scholarships to pay for those expenses, they can now get a good head start to saving for their retirement. 

Here are the specifics. 

• The account has to be open for at least 15 years.
• Conversions count as annual contributions - the most you can convert depends on the annual contribution limit ($6,500 in 2023, periodically adjusted for inflation)
• The Roth IRA must be established in the name of the 529 plan beneficiary.
• The maximum conversion allowed is $35,000

 It may take years to complete, but it is better than paying taxes and penalties for non-qualified withdrawals.

An Easier Choice for Parents and Grandparents

This was one of the better provisions of the new Secure Act 2.0.   It allows some of those funds to be used for other useful purposes without harsh penalties.  If you would like to learn more about this, please reach out to one of our advisors below.

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