This week we will look at what a 529 account is and can be used for.
A 529 is designed to facilitate education savings, proves to be a valuable addition to a financial plan for a child's education. However, uncertainties may arise regarding the use of the funds, especially if the intended beneficiary opts not to attend college or secures alternative financial aid. Recent legislative changes, particularly the SECURE 2.0 Act passed in 2022, address some of these concerns by allowing distributions from 529 accounts to be used for retirement savings starting in 2024.
The SECURE 2.0 Act enables tax- and penalty-free conversions of up to a lifetime limit of $35,000 from a 529 account to a Roth IRA owned by the 529 beneficiary for at least 15 years. This provides a unique opportunity to give the designated beneficiaries a retirement boost. It's crucial to note that the annual contribution limit and income limits for these conversions are based on the beneficiary's status, not the parent's, and apply exclusively to Roth IRAs, not traditional IRAs.
The SECURE 2.0 Act encompasses broader reforms to the American retirement system, including increased contribution amounts for older workers into qualified accounts, changes to the age for required minimum distributions (RMDs), and provisions benefiting younger workers such as employer matching for student loan payments and the establishment of emergency funds in qualified plans.
529 plans offer various tax advantages, with individual contributions up to $17,000 per year (or $34,000 per married couple) not considered taxable gifts to the beneficiary. A notable feature is the ability to front-load a 529 plan, allowing a one-time contribution of up to $85,000 per person, per beneficiary without incurring gift tax. The funds in a 529 account grow tax-deferred, and while federal deductions are not available, some states offer deductions or tax breaks on contributions.
In the context of potential nonqualified expenses, such as if the beneficiary doesn't pursue higher education, a 529 account holder may face income tax and a 10% federal tax penalty on earnings associated with the distribution. The new option to convert funds to a Roth IRA, however, presents an alternative. Several conditions must be met for a successful transfer, including a 15-year holding period for the 529 plan, adherence to Roth IRA annual contribution limits, and a cap of $35,000 per beneficiary for all transfers from 529 accounts to Roth IRAs.
It's important to note that changing the beneficiary of a 529 account is an option, allowing flexibility to redirect the funds to another eligible individual for education funding. However, if the new beneficiary belongs to a younger generation than the original designated beneficiary, potential tax implications may arise, requiring consultation with a tax professional based on specific circumstances. The SECURE 2.0 Act introduces a dynamic shift, turning 529 accounts into a versatile tool that not only supports education but also provides a pathway for retirement savings, enhancing their overall value in long-term financial planning.