You might have caught wind of this on our social channels (don't forget to follow us on LinkedIn, Facebook, or Instagram for the latest updates). The traditional 529 college savings plans, while beneficial, often lacked the flexibility many of our clients sought. The dilemma? If the child you've been diligently saving for decides against college, you were left facing a tax predicament on the withdrawn funds.
Enter the SECURE 2.0 Act of 2022, which has introduced a game-changing provision: now, unused 529 funds can be funneled into the beneficiary's Roth IRA, starting this year. This pivot towards flexibility is a significant win for savers everywhere.
The Power of Tax-Advantaged Growth
Much like a retirement plan, the 529 plan offers the sweet benefit of tax-deferred growth. The key to maximizing this advantage? Start early. The combination of your contributions and the magic of compounding over time can lead to substantial growth, tax-free, as long as the funds are used for qualified education expenses.
While these plans are state-operated, you're not bound to your home state's plan. However, some states sweeten the pot with income tax deductions or credits for contributions to their plan. It's worth weighing the performance history, goals, and associated fees of different state plans before making your choice.
Navigating the Gift Tax Landscape
2023 saw aggregate limits for 529 plans ranging between $235,000 and $550,000. And while these plans generously sidestep annual contribution limits, gifting more than $18,000 in 2024 might invite the gift tax. But there's a strategy to bypass this: the 5-Year Election, allowing a lump sum contribution of up to $90,000 in 2024, spread over five years for tax purposes.
This approach not only accelerates the account's growth but serves as a savvy estate planning move, keeping the funds out of estate tax reach.
Embracing the SECURE 2.0 Act
The ability to convert unused 529 funds into a Roth IRA for the beneficiary marks a pivotal shift. This flexibility mitigates the risk of tax penalties on unused funds, under certain conditions. The plan must be at least 15 years old, and contributions from the last five years before the transfer aren't eligible for tax-free conversion. The Roth IRA's annual contribution limits still apply, and the total conversion cannot exceed $35,000.
The Takeaway
Investing in your child's education is one of the most profound financial commitments you can make. Leveraging tax-advantaged savings options like the 529 plan, especially with the new flexibility offered by the SECURE 2.0 Act, can significantly ease the financial burden. As always, starting early is key.
Here at Fox Hill, we're committed to guiding you through these options, ensuring you're equipped to make the best decisions for your family's future. If you're pondering how to optimize your education savings strategy or have any questions, our doors (and inboxes) are always open.
PS: A recent provision of the Secure 2.0 Act will allow a limited amount of unused funds in 529 accounts to be rolled over to Roth individual retirement accounts. This change became effective in 2024, however, 2024 offers a chance to double up on the tax break and do two 529-to-Roth rollovers this year.
If you’re interested in taking advantage of this, please reach out to your advisor.
*In order to take advantage of 2023 it must be done prior to April 15.
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