Why Use a 529 College Savings Plan?

The cost of attending college, as with most expenses, continues to rise and outpace inflation. It’s a best practice to start saving for your children’s (or your own) higher education as soon as possible to reduce the amount you may have to borrow later on. Below, we explore the advantages of a 529 college savings plan under the SECURE Act 2.0.

Changes to the 529 College Savings Plan under the SECURE Act 2.0

The SECURE Act 2.0, passed in December 2022, introduced several changes to 529 plans.

The New Eligible Expenses

Two new expenses qualify for a waiver of both tax and penalty: the first expense allows for $10,000 to be withdrawn to repay the beneficiary’s student loans. Up until this change, student repayment was an ineligible expense. The account owner may also withdraw up to $10,000 to repay student loans that belong to the beneficiary’s siblings. For example, if the account beneficiary had two siblings, then an additional $20,000 is considered a qualified 529 expense if $10,000 is applied to each of the siblings’ loan balances.

A second addition to qualified expenses is the use of 529 funds for apprenticeships. This option allows a withdrawal without penalty or tax if the proceeds are used to pay the fees associated with an apprenticeship program. The only stipulation is the program must be registered and certified through the U.S. Department of Labor.

Both additions have added to the flexibility and advantages of choosing 529 plans as the saving option for your children or grandchildren’s future.

Rollover to Roth IRAs

Starting in 2024, unused funds in a 529 plan can be rolled over to a Roth IRA for the beneficiary. Conditions include:

• The 529 plan must be at least 15 years old
• Annual rollover amounts are subject to Roth IRA contribution limits
• A lifetime maximum of $35,000 applies

Saving for College: Your Options

Ultimately, there are a few different ways to save for college, each with their own advantages and disadvantages.

Traditional savings accounts

Traditional savings accounts at banks are designed for conservative individual saving. While there isn’t much return or tax benefits to keeping your funds in a savings account, it’s a viable option for an individual hoping to build a starter savings account.

UTMA Account & Coverdell ESA Funds

Uniform Transfers to Minors Act (UTMA) account funds can be used for anything related to care for a child; therefore, it can be applied to a child’s college education. The challenge of using this account is that the funds belong to the beneficiary once they reach the age of 21 and can be used freely. Thus, these funds can be contributed to post-secondary education expenses but are not specifically designed for this purpose.

A Coverdell Education Savings Account (Coverdell ESA) is a reliable option for investing in a child’s college education. However, these accounts are not often preferable to a 529 college savings plan, as a Coverdell ESA has lower contribution limits.

529 College Savings Plans

A 529 college savings plan tends to be the most appropriate avenue to save for college, as it comes with different tax benefits and a parent/custodian maintains control of the assets regardless of the beneficiary’s age. The savings collected in a 529 college savings plan can also be invested in stock mutual funds, bond mutual funds, or asset allocation mutual funds, providing various options for your investments.

Each state sponsors its own 529 plan; however, you can use any state’s plan regardless of where you reside. Most states provide a state tax deduction or credit on contributions to the plan, and you won’t be taxed on the gain if it is used for qualifying education expenses.

Eligible Expenses & Institutions

Qualified expenses include:

• Tuition and fees
• Books and supplies
• Expenses for special needs services
• Purchase of a computer or software necessary for completing assignments
• Repayment of student loans
• Room and board, if enrolled at least half-time
• If the beneficiary obtains a scholarship or receives free tuition under the GI Bill, you may withdraw amounts equal to the value of the scholarship and avoid a 10% penalty. You must still pay tax on the earnings

Qualified institutions included in tax-free withdrawal:

• Four-year colleges (both for undergraduate and graduate school)
• Community colleges
• Apprenticeships
• Some technical schools
• Some states allow for qualified withdrawals for K-12 private school tuition (up to $10,000 can be withdrawn each year per beneficiary)

Non-eligible Expenses

There are several items that do not qualify as education expenses, including personal living expenses, transportation to and from school, student insurance premiums, and Greek life membership dues. In the event that you withdraw contributions for non-qualified expenses, you will have to pay the income tax you avoided, as well as a 10% penalty on investment gain over original contributions.

Key Takeaways

A 529 college savings plan provides tax benefits and other advantages for individuals building a savings fund for higher education costs. To learn more about your options and how to start a 529 plan, please contact a Sikich Financial professional.

Investment advisory services offered through Sikich Financial, an SEC registered investment advisor.