A 529 Plan is an education savings plan sponsored by the state or a state agency. They are a great savings tool because the money invested in a 529 plan grows tax-deferred, and qualified distributions are tax-free. Traditionally, the “qualified distributions” in a 529 plan are designated to a beneficiary to pay for certain college expenses. Recently, updates to the FASFA and changes within SECURE 2.0 regarding retirement savings both contained legislation that help a 529 make an ever greater impact.
529 Plan Changes with FAFSA
In 2021 Congress passed The FAFSA Simplification Act (FSA) as part of the Consolidated Appropriations Act of 2021. The goal of the FSA is to make the form easier to complete while also updating the rules surrounding student aid eligibility. The change that affects 529 plans is in regards to “cash support”. In the past, any money given to a student to help him/her pay for college was counted as the student’s non-taxed income. Higher income means lower financial aid.
Under the new FSA rules, which are currently set to be in place for the 2023-2024 school year, cash support will no longer be considered income to the student. This means a grandparent or other relative can set up a 529 Plan for a child and when they go to college, those funds will not affect the amount of federal aid the student will receive. If you’d like to read about other changes the FSA will have on FASFA, read our blog.
529 Plan Changes with SECURE 2.0
SECURE Act 2.0 was signed into law in late 2022. It contains legislation updates designed to help individuals gain more/easier access to their retirement savings. The updates the ability to transfer 529 plan funds into a Roth IRA for the same beneficiary without paying taxes or penalties.
As you can read in the next section of this blog, the funds in a 529 plan can only be used for “qualified expenses” without incurring a withdrawal penalty. So, what happens if the beneficiary chooses to not attend college or if they do attend, but they do not need all the money that has been saved? This new legislation provides a solution.
Starting in 2024, beneficiaries of 529 college savings accounts may transfer up to $35,000 of unused funds over the course of their lifetime directly to a Roth IRA. Here are the limitations:
- The Roth IRA is still subject to annual contribution limits (in 2023 this amount is $6,500, so it will take several years of transfers to reach the maximum of $35,000).
- The 529 account must have been open for more than 15 years.
- Any contributions made in the last 5 years to the 529 cannot be transferred tax-free.
- The owner of the Roth must be the same person who is named as beneficiary of the 529 account.
Though there are limitations, this creates an easy way for families to save money in a 529 education plan without the worry of penalties or income tax in the event the money isn’t used for education.
529 Plan Flexibility
While these new pieces of legislation will help a 529 make a greater impact on a child’s future, it’s also important to know what a 529 plan is designed to do. This section will cover some of the basics of flexibility and restrictions that come with using a 529 plan as a savings tool.
529 Plan Restrictions
The primary restriction with 529 Plans is what the funds can/can’t be used for upon withdrawal. Typically, tuition and required books are covered along with restrictions on supplies, room and board, and other needs, but expenses such as transportation and health insurance are not. Additionally, the beneficiary must withdraw money in the year the expense is incurred the expense. You can’t incur an expense in one year and withdraw from the 529 plan in a different year.
If the 529 funds are used to pay for non-qualified expenses, you’ll be hit with two penalties. First, the account owner will incur income taxes on the earnings portion of the distribution used for the non-qualified expenses. Second, the owner will pay an additional 10% penalty on those earnings.
529 Plan: Why Not?
A 529 Plan is a flexible option – and with the new legislation, it’s becoming more and more useful! If you want to set aside funds for education or if you’re interested in other wealth planning services, we’re here to help you prepare for a sound financial future. Contact us today to set up a meeting!
Chris is a Strategic Analyst who maintains expertise in litigation support, international taxation, and complex entity and fiduciary taxation services.