Education is important in our society, and one of the most frequent questions we hear from parents and grandparents is, “how do I provide for my child’s/grandchild’s education?”
Last year in our article, How to Maximize College Tuition Payments, we discussed different options for paying for college. One of the tools we highlighted in that article was the 529 college savings plan. This is a savings vehicle whereby traditionally money is put away for a student to use in the future. If the plan is used for college expenses such as tuition, books and supplies, computers and internet access, and room and board (if the student is enrolled at 50 percent), then the growth on the original amount is not subject to federal income tax.
We have advised many parents and grandparents to start 529 plans for their children and grandchildren over the years while the child is young so that the money has time to grow before the child heads off to college. That sounds great, but one question we often get about these plans is — what if my child/grandchild doesn’t use all the money in the plan for college?
Great news because the plans have been so successful that the list of penalty-free uses has expanded in recent years. As one may expect, most of these are education related.
1) Transfer the plan to another beneficiary—This has been the traditional answer. If your child or grandchild doesn’t use all the money, then the plan can be transferred to a sibling, parent, grandchild, etc. This becomes an excellent vehicle for transferring the gift of a college education to future generations. Be aware, though, that there could be some gift tax consequences to doing this, so make sure to talk to your Resource Consulting Group advisor.
2) Scholarships—If your student receives a scholarship, they can still withdraw money from the plan up to the scholarship amount without incurring the 10% penalty, but there is still a requirement to pay income tax on the earnings.
3) Private School—If it looks like your child or grandchild may not use all the money, you may wish to use it to pay for another child or grandchild’s private school education. Withdrawals from 529 plans can be used to pay up to $10,000 yearly in private elementary through high school tuition.
4) Student Loans—Up to $10,000 from the 529 plan can be used to pay down student loans.
5) Continuing Education – If your student enters a field that requires continuing education, such as nursing, law, or education, as long as they take their continuing education courses from a school that accepts federal aid, the 529 plan can be used to pay these expenses.
In December 2022, Congress passed a new bill allowing 529 plans to be used for something non-education related. Starting in 2024, a 529 plan can be used to fund a Roth IRA of a beneficiary up to the annual limitation (in 2023, it is $6,500) up to a lifetime cap of $35,000. There are a couple of caveats: 1) the 529 plan must have been open for at least 15 years, and 2) any contributions made in the past five years (or the earnings on those contributions) cannot be rolled over into a Roth IRA.
This can be a great tool for a young person who may not have the cash flow to make Roth IRA contributions during those prime early earning years. This can help get them on the right foot to save for retirement at a time when other cash expenditures likely have higher priority. This is a very long-term play, so new parents and grandparents may consider opening a 529 plan for young children and fund it even with a minimal amount to get the 15-year clock running. This gives everyone the most flexibility to take advantage of this tool should you choose to when the circumstances are right.
This is also a great indication of the types of creative solutions that will continue to incentivize parents to save for their children’s future. Creating more flexibility in 529 plans traditionally made solely for college education will likely be a continuing trend. This should help give parents and grandparents more comfort in funding these plans when children are young.
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