529 plans, the popular tax-advantaged plans for education savings, are an important part of many families’ strategies for paying for college. The primary attraction is obvious – funds deposited into a 529 plan grow income-tax free and can be withdrawn tax-free so long as they are used for “qualified education expenses”, which until recently meant tuition, fees, room and board, textbooks and other essentials at a college or graduate school. Although there is no federal income tax deduction for the contribution, many states provide a state tax deduction for funds deposited in a 529 plan.
In the past, some people may have hesitated to invest because of the limitation to post-secondary school expenses or concerns about what would happen to excess funds if they weren’t needed for a beneficiary’s education. Recent legislative changes may help to alleviate those concerns and broaden the appeal of 529 plans. A summary of these changes is as follows:
- K-12 Education. Funds in a 529 plan can now be used for tuition payments for K-12 education (up to $10,000 per year per child), including public, private, and religious schools. Since a chief advantage of a 529 plan is the opportunity for funds to grow tax-free over time, however, spending them in the early years of a child’s education may not be the most effective use in many cases.
- Student Loan Repayment. The 2019 SECURE Act allowed for funds from a 529 plan to be used to pay off student loan debt for the account beneficiary or their sibling, up to a lifetime maximum of $10,000.
- Apprenticeships. The SECURE Act also permitted the use of 529 funds to pay for required fees, books, supplies and equipment for apprenticeship programs registered and certified with the U.S. Department of Labor.
- Grandparent-Owned 529 Plans. Under the new FAFSA (Free Application for Federal Student Aid) rules, distributions from 529 accounts owned by grandparents will no longer be treated as unearned income, which previously had an adverse impact on a grandchild’s financial aid eligibility.
- Roth IRA Rollovers. Beginning this year, excess funds in a 529 plan can be used to fund a Roth IRA for the plan beneficiary, subject to certain restrictions including:
- A lifetime limit of $35,000 per beneficiary.
- The 529 plan must have been in existence for at least 15 years, and the funds to be rolled over must have been in the account for at least five years.
- The maximum that can be rolled over in a year is the beneficiary’s IRA contribution limit for that year (currently $7,000), less any other IRA contributions that year by the beneficiary.
- The beneficiary must have earned income at least equal to the contribution.
- The rollover must be a plan-to-plan or trustee-to-trustee rollover, not a withdrawal from the 529 plan followed by a deposit into the IRA.
For those who can meet these restrictions, this may be a good head start on saving for retirement for the beneficiary.
- Increased Funding Opportunity. Although there is no restriction on annual contributions to a 529 plan other than the cap on total contributions set by each state, most people choose to keep their contributions within the annual gift tax exclusion to avoid gift tax issues. That limit has increased to $18,000 per person in 2024. For those wishing to “superfund” a plan by making up to five years’ worth of contributions in a single year, this raises the amount an individual can give to a 529 plan in a year without gift tax implications to $90,000 ($180,000 for a married couple).
As these recent changes show, Congress has continued to broaden the scope and flexibility of 529 plans over time. However, 529 plans are state-run, and states vary in their treatment of these changes with respect to their own income taxes. In some states, a withdrawal that is permitted for federal income tax purposes may incur state income tax, so you will want to be sure you understand the parameters of your own state plan.
By Elizabeth Hefferon