Americans have expected the next generation to have better lives than them throughout our history. Overall, it’s been true, with each generation creating more wealth and opportunities.
For this and other reasons, grandparents, aunts, uncles and parents want to jump start their children’s future.
A popular way to save for the next generation is a 529 plan. 529 plans come in two varieties: college savings plans and prepaid tuition plans. 529 plans are sponsored by individual states, and each has their own plans and benefits, so it pays to know the rules in the state you live in.
Pennsylvania offers two plans: the PA 529 Guaranteed Savings Plan (GSP) or PA 529 Investment Plan (the Plan). With the GSP, the account owner or beneficiary must be a Pennsylvania resident. Vanguard Group is the investment manager for the IP. There are over 100 529 education savings plans, including the PA plans.
For Pennsylvania, a state inheritance exemption may apply depending on the relationship between the deceased account owner and heirs.
A 529 has an owner, typically the person who funds the account, and a beneficiary, the person who will hopefully use the account for education. The owner controls distributions and investments, and can also change the beneficiary.
The federal taxation for 529 plans works similarly to a Roth IRA. Contributions go into 529 plans after-tax, and the benefit comes when money is withdrawn. If money is withdrawn from a 529 for qualified education expenses for the beneficiary, the withdrawal is tax-free. Qualified benefits include student loan payments, books, computer technology or equipment, tuition, fees and room and board. Recently, the benefit broadened to include up to $10,000 per year for private primary or secondary education tuition.
Up until this year, money taken out of a 529 and not used for education would be taxed and receive a 10% federal income tax penalty. For parents whose children are young, the uncertainty of their need for higher education can stop them from using this advantageous plan. A new rule makes this less of an issue for adults thinking about opening a 529.
Starting this year, the SECURE 2.0 Act provides an opportunity to roll 529 plan funds to the beneficiary’s Roth IRA. A 529 owner that wants to do this needs to review the rules before moving forward.
To be eligible for the Roth rollover/contribution, the 529 must be 15 years old (for 2024, the account would need to be opened in 2009 or earlier). The Roth IRA owner also must have earned income in the year of the rollover and must follow the Roth IRA contribution limits. For 2024, the Roth contribution limit is $7,000 (for Roth owners younger than 50 years of age), so the 529 owner would need to earn $7,000 or more to be eligible to roll the money into the beneficiary’s Roth. The contribution takes the place of a contribution from the beneficiary.
The $7,000 must also have been contributed to the 529 at least five years ago. Therefore, for 2024, the money being rolled to the Roth would need to be contributed in 2019 or before to be moved. There is a lifetime limit and 529 transfers to Roth are limited to $35,000. There are still things to be clarified in the rule, such as: does a change in beneficiary start the 15-year requirement again?
There are other avenues for savings for a minor’s future with different benefits and disadvantages. With the new change, more people will find a 529 hard to resist with the tax benefits. For help in deciding on the best options for your savings for a minor, consult with an advisor, who can review all the options with you.
Judy Loy is a Registered Investment Advisor, ChFC®, RICP® and CEO of Nestlerode & Loy, Inc. in State College.
All investing is subject to risk, including possible loss of the money you invest. Nothing in this article should be construed as investment or retirement advice. Always consult with a professional advisor and consider your risk tolerance and time to invest when making investment decisions. Review your personal situation with a professional before planning any gifting or estate planning.
