529 Plan Updates Under SECURE 2.0 Act
The best way to save for college for your children and grandchildren is a 529 college savings plan. And the recent SECURE 2.0 Act legislation created some improvements on this great product. The tax advantages make 529 plans the clear winner for college planning and saving.
Money saved in a 529 college savings plan can be invested to grow tax-free over the years and then be withdrawn and used tax-free to pay for any college in any state. Qualified educational expenses include tuition, room and board (if attending at least half-time), books and fees paid in the same year as the withdrawal is made.
When it comes to financial aid, money in a 529 plan has a far lower impact in the aid formula than assets held in a custodial account for the child. A separate account must be opened for each child, although money can later be used to pay for other children in the family, if one gets a scholarship or does not attend college.
Each state has set up its own 529 program, and you can participate in your own state’s plan or in any state’s plan. You might base that decision on the performance of the investments within the plan. Check out those performance ratings at SavingforCollege.com or Morningstar.com. A reason to choose the plan of the state where you reside is if it offers a tax deduction for some of your contributions.
Some states offer both an “investment” plan and a prepaid tuition plan. Stick with the investment type plan, since prepaid tuition plans limit choices to in-state schools and ultimate payouts may depend on availability of state funds.
Most states offer investment-type plans that are sold directly on their website or through financial services firms. The latter can have higher up-front and ongoing fees for essentially the same investments. Go directly to the plan website to open your account.
The 529 investment plans offer choices — typically an age-based plan that invests more aggressively for younger children and moves to more conservative choices as college nears. Or you may have a choice of mutual funds. But you are limited by law to two investment changes each year. The value of the account goes up and down with market performance of the investments.
There is no maximum annual contribution (although states set maximums for their plans), but gifts over the annual gift tax exclusion amount ($17,000) can trigger the need to file a gift tax return. One exception allows a combination of five years of the allowable gift at one time — a total of $85,000 in 2023 — allowing wealthy grandparents to get money out of their taxable estate!
But you can easily start small. Most state plans allow you to set up an account with as little as $25 and subsequent contributions of $15. They also help you set up automatic withdrawal plans from your checking account to keep the fund growing. And anyone — parent, grandparent or friends — can make contributions to the plan for birthday and holiday gifts.
The new tax law changes mean a parent or grandparent can open the account with the same impact on financial aid. (In the past, withdrawals from grandparent-owned accounts impacted aid more heavily.) In fact, each could open separate accounts for the same child.
Until now the only choice for excess funds was to share the fund with another qualifying child (or let the money grow for a future grandchild!) If the money is withdrawn for non-college purposes, it is subject to a 10% penalty and ordinary income taxes on the gains.
But under the SECURE 2.0 Act, starting in 2024, accounts that have been held at least 15 years can be rolled over to a Roth IRA for the owner or beneficiary, subject to the annual contribution limits and with a maximum of $35,000. However, you cannot roll over any contributions made in the last five years.
Start saving for college now in a 529 plan. Time is money. And that’s The Savage Truth.
(Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” Terry responds to questions on her blog at TerrySavage.com.)
©2023 Terry Savage. Distributed by Tribune Content Agency, LLC.