Most of our wealth management clients with children ask about opening 529 plans. They feel eager to achieve college savings goals (even before their children are born).
We love seeing this kind of enthusiasm and productivity. But it was only recently that I felt more enthusiastic myself about 529 plans.
Before 2023, I would caution my clients against overfunding a 529 for their child’s education. With a recent regulatory change, I’m more confident suggesting the use of a 529 plan for more families.
That’s especially true for those who feel passionate about creating generational wealth.
Here’s why hedged a bit on 529 plans before, and what changed to make me see these as more attractive investment vehicles for my wealth management clients (and my own family).
Why We Used To Advocate For a Split Savings Approach
In the past, I didn’t see 529 plans as the default, without-question, number-one choice for a college savings vehicle.
Yes, they offer tax advantages which are important. But there are other considerations to work through to determine:
- If a 529 plan is the best account to use for your family’s specific goals, and
- How much you should contribute to that account, versus other investment vehicles, to meet those stated goals.
Specifically, I talked to my clients about the fact that:
- The future is always uncertain, especially the farther out you’re trying to plan for. Families with infants or toddlers have a long way to go to the college years. So much can change between now and then (including factors that are in and out of your personal control).
- Their own retirement needs should come before almost any other goal — including school funding. There are multiple ways to pay for an education, but most people only have one option for retirement income: their own savings that they built up over a working career.
- They might incur penalties if they need to use the money in a 529 plan for anything but qualified education expenses.
For clients who highly valued flexibility, we usually suggested putting some money for college int0 a 529 plan.
They could contribute the remaining dollars earmarked for a child’s college costs into something like a brokerage account. Taxable investment accounts offer no tax advantages, but there are also no limitations on how, when, or why the money is used.
Plus, having a 529 plan open allowed for other family members to contribute to a child’s future education — even if the parents didn’t want to fund the plan themselves or opted to use a taxable brokerage account for that purpose instead to maximize future flexibility.
This “split” approach helped avoid the risk of overfunding a 529 plan. But the signing of the SECURE 2.0 Act into law in December 2022 created new rules on a variety of investment accounts — including 529 plans — which made them more appealing tools to use as part of an overall financial plan.
The Rules That Gave The 529 Plan More Flexibility
When 529 plans were first introduced, they were clearly designed to be college savings only vehicles. Withdrawals from the plans had to go toward qualified education expenses with higher education.
Money used for any purpose outside those boundaries was subject to taxes and penalties.
The SECURE 2.0 Act was not the first piece of legislation to ease up on the strict rules governing use of funds from 529 plans.
A few years ago, new legislation allowed for families to use 529 plan funds not just on college costs but also some private grade or high school expenses.
This increased flexibility for 529 plans, but still largely kept rules in place that limited families to spending on education from the account.
After the SECURE 2.o Act, however, families now have even more options for how they use the money they’ve saved into 529 plans… including one strategy that supports efforts to create generational wealth.
Building Generational Wealth With 529 Plan Dollars
If you’re the custodian of a 529 plan, the SECURE 2.0 Act gave you the ability to roll some of the money you saved into the plan to a Roth IRA in the future.
Specifically, if you have a 529 plan that you opened at least 15 years ago, the beneficiary of that account can roll up to the current Roth IRA contribution limit into their Roth IRA each year.
(The Roth contribution limit for 2023 is $6,500. It will be $7,000 in 2024. This figure tends to increase over time to reflect inflation.)
You can open and contribute to a Roth IRA for your minor children so long as they have earned income for the year. Just as with 529 plans, you serve as the custodian to the account; when your child reaches 18, they can take control over the Roth IRA.
This gives families a lot of flexibility, especially if a potential stint at a university is still a long way into the future and you feel uncertain as to whether your kids will go to college at all.
You can save into the 529 plan, and down the road, either use those savings for college or roll money into a Roth IRA for your child once they start working.
Either way, you’re building up assets for the next generation to use to secure their own financial future — and that is a powerful action for any parent to take.
Remember, You Can Change 529 Plan Beneficiaries — Which Means The Potential To Contribute To Multiple Family Members’ Roth IRAs
You can change the beneficiary on a 529 plan. Previously, that gave you the ability to fund multiple children’s education costs with one plan.
If your first child did not use up all the funds in the 529 plan, you could change the beneficiary to a younger child and pay for their qualified expenses, too.
You could even change the beneficiary to yourself or a spouse, if you chose to go back to school at some point during your career.
The ability to change the beneficiary to other family members is still in place with 529 plans, and that combined with the new rules that allow for rollovers to Roth IRAs, means that you could potentially roll 529 plan money into multiple immediate family members’ Roth IRAs (so long as that family member has earned income reportable to the IRS).
This could be a helpful strategy to deploy, depending on your savings habits and size of your household. There are limits on how much you can roll over into a single Roth IRA; based on the current rules, only $35,000 total can be moved from a 529 plan to an individual beneficiary’s Roth IRA.
But if you have more than $35,000 in a 529 plan that you want to roll over, you can still do it — if you can change the beneficiary on the 529 plan.
Once you hit the rollover limit for one family member, you could change the 529 plan beneficiary to another member of the family with earned income and continue doing rollovers into their Roth IRA.
This allows you to contribute to a child’s college fund, help jumpstart their retirement savings, or even catch up on your own retirement savings if needed down the road by rolling over 529 plan money into your Roth IRA.
Increased Flexibility Give Families More Financial Power With 529 Plans
One of the key points to keep in mind here is that to be eligible for rollovers, the 529 plan needs to be at least 15 years old — which means if you haven’t opened one yet, now is a great time to consider it.
It’s a great potential tool to incorporate into your future planning, and one with the power to help mutliple members of your family grow wealth.
Another key point? All of this information and great strategies like this one are wonderful to know… but you still have to take the additional step of applying the details to the specifics of your unique situation.
Not all strategies fit all scenarios, and what looks good on paper may not work well in the context of your actual life. It’s always smart to run ideas and strategies past your personal financial advisor, and ask for their help in determining whether or not it makes sense to implement.
