The cost of college tuition goes up by the year, and for those families who are able to afford it at all, it’s one of the biggest expenditures they’ll ever make, next to a house or a car.
Since the late 1980s, when the state of Michigan created the first prepaid college savings vehicle, more than 12 million families have used what are now called Section 529 Plans to save a total of $258 billion toward the cost of education, according to the College Savings Plans Network.
Section 529 Plans offer a huge advantage in that as long as the money is used for a qualified purpose, such as college or K-12 schooling, the income from it is never taxed. Families who establish a 529 Plan when their children are born, then continue adding to it for 18 years, can accumulate a sizable nest egg that greatly relieves the financial burden often experienced when a child begins their first year of college.
One additional perk of 529 Plans is that families can front-load their initial contribution, bundling together five years worth of tax-exempt gift credits at once. During 2023, the gift tax exemption is $17,000, meaning that each individual can contribute $85,000, or $170,000 for a couple. This strategy has the added benefit of removing these funds from a family’s estate, potentially reducing inheritance taxes down the line.
Thanks to some new rule changes passed as part of the SECURE 2.0 Act, 529 Plans are an even better option for families than they were in the past. One big improvement is that it’s now easier for nonparent family members to contribute to 529s. Previously, distributions from 529s that weren’t owned by the parent or the student had to be reported as cash support on the Free Application for Federal Student Aid (FAFSA) form. This money counted against a student’s eligibility for financial aid, cutting the available amount by as much as 50 percent.
Under the new rules, which go into effect in 2024, this reporting is no longer required, freeing up other family members, such as grandparents, to contribute to their loved ones’ future education. It really can be more meaningful for grandparents to contribute toward something like this, which may not be as fun as a new dollhouse or video game, but will ultimately have a much greater impact on their grandchildren’s lives.
One reason some families hesitate to start 529 Plans is because it’s impossible to know whether the money will even be needed when the time comes. Some students may receive a scholarship that covers their college costs, while others may not have a desire to attend college at all. Up until now, parents whose children don’t need the money in the family’s 529 Plan have only been able to withdraw funds by paying a 10 percent tax on their earnings.
Under the new rules taking effect in 2024, parents will be able to roll over any unused 529 money tax-free into a Roth IRA for the beneficiary. There are, of course, a few restrictions — the 529 has to have been open for 15 years and have the same beneficiary that entire time, and annual rollover amounts are limited to the same yearly contribution limit as Roth IRAs ($6,500 in 2023). There’s a lifetime rollover limit of $35,000 as well, and any contributions made in the previous five years can’t be rolled over. Regardless, this is a powerful new option for parents to help their children start saving for retirement.
As we continue to examine the nuances of these new rules, there may be additional benefits for families yet to be uncovered. At Heritage, we’re glad to help walk our clients through what these changes can mean for them and navigate possible scenarios.
One of the most important gifts parents can give their children is knowledge. We’re happy to be a knowledgeable partner to our clients in utilizing the benefits of 529 Plans and other financial planning strategies to make the future costs of education manageable.