Important Changes to 529 College Savings Plans
By Trent Derrick, CMT®
You may have heard the saying “The days are long but the years are short.” If you are a parent, you understand this all too well. If your kids are young, you may not be thinking about college just yet, but before you know it, they’ll be touring campuses and filling out applications. That’s why it’s important to plan ahead. If you haven’t started saving for college, there’s still time. One of the best ways to set aside funds for this important milestone is with a 529 college savings plan. In this article, I discuss some features of this plan as well as important changes made in 2024 to the 529 college savings plan.
Why Saving for College Is Important
Tuition rates have increased at a faster pace than many other expenses over the past decade, rising 9.24% from 2010 to 2022 for a four-year public institution. (1) As with retirement savings, starting early and harnessing the power of compound interest is the key to a successful college savings plan. With that in mind, let’s discuss six important benefits of using a 529 plan to save for college.
Features of a 529 College Savings Plan
A 529 plan is a state-sponsored education savings account that allows earnings to grow tax-free. There are two categories of 529 plans: prepaid tuition plans and college savings plans.
Prepaid plans let you lock in future tuition costs at today’s prices, which can be enticing. On the other hand, college savings plans have no age or income restrictions. While there are no annual contribution limits for college savings plans, there are maximum aggregate limits. These are state-specific and vary anywhere from $235,000 to $550,000 per child. (2) You can then use these assets tax-free for qualified education expenses. It’s important to note that these aggregate contribution limits are as of 2023 and have not yet been updated for 2024, so they may be adjusted.
1. Tax-Free Earnings
You do not have to pay taxes on earnings in a 529 as long as the funds are used for qualifying higher-education costs. (3)
2. State Tax Deductions
Many states offer income tax deductions for contributions made by residents of their state, but you should check to confirm. For example, California does not provide a deduction, (4) but South Carolina taxpayers may deduct up to 100% of 529 plan contributions. (5)
3. Plan Flexibility
One of the benefits of 529 plans is that you can transfer the funds to another family member or relative if your child does not end up using the assets.
Contributing to a 529 plan is not a privilege reserved for the parents of the beneficiary. Anyone can contribute to your child’s college savings plan, including grandparents or other family members.
529 plans can be a useful estate planning tool for grandparents interested in helping to fund a child’s college expenses. As of 2024, a grandparent can contribute up to $18,000 per year (up to $36,000 for a married couple) to a beneficiary’s plan free from federal gift taxes. (6) They can also accelerate the gifting schedule by making a lump-sum contribution of up to $90,000 to a grandchild’s 529 plan in the first year of a five-year term (up to $180,000 for a married couple filing jointly). (7) To help illustrate the wealth transfer benefits of this approach, a grandparent with five grandchildren could immediately remove up to $90,000 from their taxable estate by contributing to five separate 529 plan accounts.
4. Alternate Ways to Use the Money
If your child chooses not to go to a four-year college, the good news is that you can still use your savings from a 529 account for other things. Account holders can use up to $10,000 annually on pre-college educational expenses, such as K-12 private or religious school tuition. (8) This includes tuition expenses at private, public, and religious K-12 schools. And thanks to the SECURE Act of 2019, you can also use your 529 savings to pay for apprenticeship fees or up to $10,000 of qualified student loan repayments (including those for the 529 plan recipient’s siblings). (9)
5. Control of Funds
There is no need to worry about the beneficiary mishandling the funds because you, the account holder, remain in control of the assets. The child you are saving money for is the named beneficiary of the account, but you are still the account owner and they cannot bypass you to access the funds.
6. Financial Aid Is Still Possible
Your child’s 529 account does factor into the Free Application for Federal Student Aid (FAFSA) calculation if the account is in the parent’s name. (10) Up to 5.64% of the parent’s assets will count against the student’s financial aid eligibility. A 529 plan owned by a grandparent, however, does NOT impact a student’s eligibility for need-based financial aid. (11) Previously, while a grandparent-owned 529 plan was not counted on the FAFSA, the distributions were considered untaxed income for the student and would, therefore, affect their eligibility for need-based financial aid. Starting with the 2024-25 school year, however, these distributions will no longer be reported, which means a student may be eligible for more financial aid.
Important Changes for 2024
As of Jan. 1, 2024, a change in the rules for 529 education savings plans allows excess money not used for a beneficiary’s education to be rolled over to a Roth individual retirement account (IRA). (12) The new law allows up to $35,000 over a lifetime to be rolled over from a 529 plan to a Roth IRA—and that process is tax-free and penalty-free. Both savings vehicles are funded by after-tax dollars.
How It Works
As always, you have to go to the fine print to see what’s going on. While the change is likely to be welcomed by many parents, Congress put up some guardrails that may not help you immediately unless you’re planning well ahead. Here are the rules for converting the money in a 529 plan to a Roth IRA:
- You must have had your 529 account for at least 15 years.
- Your yearly conversion is capped at the annual IRA contribution limit.
- Money eligible to be rolled over must have been in your 529 plan for at least five years.
- The owner of the Roth IRA must be the same as the beneficiary of the 529 plan.
Keep these rules in mind and be careful about the choices you make relating to your 529 plan. For instance, you could reassign the beneficiary—another child, a niece, or a nephew—and the 15-year period would start over again. And since the rules are new, Congress may continue to tweak them. Keep in mind that there may be more to come.
Ready to Start Saving?
If you have held off on saving for your kid’s college with a 529 college savings plan because you felt it was too restrictive, then the recent changes are good news. There are many advantages to a 529 plan, but now one of the disadvantages has been removed, making it even easier to save for college or other educational expenses.
At Legacy Wealth Management, we can review your options for setting aside funds for college so you can make the best decision for your family. We also provide comprehensive financial services tailored to your unique situation. We would love to answer your questions, explain your options, and help you move toward your financial goals. To get in touch, email me at trent@legacywm.com.
About Trent
Trent Derrick is a financial advisor and Chief Market Technician at Legacy Wealth Management. He is passionate about the value small businesses bring to their communities and specializes in serving small business owners by providing seamless financial advisory services tailored to their financial needs, including tax planning strategies, cash flow management, and retirement planning. Trent obtained his bachelor’s degree from the College of Charleston, studied economics at the University of South Carolina, Columbia, and is a Chartered Market Technician® (CMT®) professional. Outside of the office, he serves as a guest lecturer for the College of Charleston’s MBA program and acts as chairman of the Market Technician Association’s Charleston chapter. To learn more about Trent, connect with him on LinkedIn.
The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
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(1) https://educationdata.org/college-tuition-inflation-rate
(3) https://www.irs.gov/credits-deductions/individuals/qualified-ed-expenses
(4) https://smartasset.com/taxes/529-plan-tax-deductions-for-every-state
(5) https://futurescholar.com/refund/
(7) https://www.savingforcollege.com/article/10-rules-for-superfunding-a-529-plan
(8) https://www.savingforcollege.com/article/529-savings-plans-and-private-school-tuition
(9) https://www.savingforcollege.com/article/strategies-for-using-a-529-plan-to-repay-student-loans
(10) https://www.savingforcollege.com/article/yes-your-529-plan-will-affect-financial-aid
(11) https://www.savingforcollege.com/article/new-fafsa-removes-roadblocks-for-grandparent-529-plans