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College savings that have become stranded can soon be rescued. A new law allows 529 plan funds to be rolled over into retirement accounts.

Because children’s opinions change frequently, it’s understandable that parents may be hesitant to invest money in a college savings plan. After all, what if your child decides to skip or drop out of college? That money could have gone elsewhere.

You can relax for the time being. That unused education funding can be reclaimed soon.

“People who have unused college savings may be able to roll those funds over into retirement savings rather than having to withdraw them and incur tax penalties,” said Keith Namiot, chief operating officer at Equitable Group Retirement.

What has changed with 529 college savings plans?

Starting in 2024, the $1.7 trillion federal omnibus spending bill passed late last year includes a provision that allows tax-free rollovers of up to $35,000 from 529 tuition savings plans to Roth individual retirement accounts.

Rollovers can begin only if the funds have been in a 529 plan for at least 15 years. The amount is also subject to Roth IRA annual limits. The contribution limit for 2024 is $6,500, with a $1,000 catch-up allowance for those over the age of 50.

Current rules require that any leftover funds remain in a 529 plan and be used for qualified education expenses, or they must be withdrawn and subject to a 10% penalty and federal income tax on the earnings. Sure, you could change the beneficiary to another family member, such as a grandchild, niece or nephew, sibling, or even yourself, but let’s face it: you probably don’t want to pay for anyone else’s education except your own. You might not have to anymore.

“This is a huge deal,” said Lift Financial managing member John Bergquist. “It opens the possibility on the backend to do something with the money. This will encourage people to invest in 529 plans or at least investigate them further.”

How significant is this change?

Derek Pszenny, financial adviser and co-founder of Carolina Wealth Management, crunched some numbers to demonstrate:

Assume you’ve transferred the $35,000 lifetime cap from the 529 to the Roth IRA by the time your child graduates from college at the age of 22. Based on 9% annual compound growth (the S&P 500 has historically returned around 10% per year), that amount will have grown to $1.6 million by the time your child reaches retirement age.
“That’s when I started getting really excited,” Pszenny said. “Then you start to wonder how you can save a couple hundred dollars right now.”

Furthermore, knowing that any remaining savings can be used to fund their retirement “can be an incentive (for kids) to be frugal about where they decide to go to college,” he said.

Are there any additional advantages to 529 education savings plans?

Yes.

Prepaid and savings 529 plans, also known as qualified tuition programmes, are available.

Both are provided by states, so they may differ slightly from one another, and both allow you to change the beneficiaries of your plan to another family member if the money is unused. The savings plan, on the other hand, is more popular due to its flexibility, which includes the Roth IRA rollover next year.

The following are the main points of each plan:

Prepaid plans allow you to prepay and lock in tuition at today’s rates at eligible public and private colleges or universities, but they typically do not cover other expenses like room and board. They may also require state residency when applying and may limit enrollment to a specific time period each year. Beneficiaries are often restricted based on their age or grade level.
Savings plans do not require state residency, so you can save in a plan in any state across the country. However, some states allow you to deduct your contributions from your state income tax (or receive a state tax credit), making your local plan the best financial option for you. You choose your investments, earnings grow tax-deferred, and withdrawals are tax-free when used for qualified education expenses such as K-12 tuition and fees (up to $10,000 per beneficiary per year), college, graduate school, and trade school tuition and fees; books and supplies; technology costs; and even student loan repayments.

What is superfunding and how does it work?

Superfunding, which is mostly used by high-net-worth individuals and the elderly, allows you to front-load your 529 savings plan by making five years’ worth of contributions all at once. Contributions count toward your $16,000 annual gift tax exclusion in 2022.

“It can be a good vehicle for people who are concerned about estate planning,” said Joel Dickson, Vanguard’s head of enterprise advice methodology. “It doesn’t really change the annual amount you can give, but it can get it out of the estate so it’s not subject to estate taxes.”

Former President Barack Obama and his wife made superfunding famous in 2007 when they contributed a total of $240,000 to their two daughters’ 529 savings plans. Because the annual gift tax exclusion was $12,000 that year, each of the parents funded $60,000 (5 years x $12,000) to each daughter and avoided paying taxes on the amounts without using up their lifetime gift tax exemptions.

Individuals can give away a certain amount of money over their lifetimes without paying federal gift tax, according to the IRS. It is distinct from the amount you can give away tax-free each year.

How do I know which plan is best for me when each state has its own?

Do your homework.

Online tools can help you compare the various plans that states offer, taking into account fees, investment options, and tax savings. College Savings Plans Network, an affiliate of the professional, nonpartisan National Association of State Treasurers organisation, and the not-for-profit College Savings Foundation are good places to start.

However, Dickson offers some general guidelines to help families get started saving for college:

And keep in mind that “now that there is more flexibility to use 529 proceeds, there is a little less angst that contributions will be locked up,” he said. “This should alleviate some of the concerns, particularly among parents with young children.”

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