529 Plans and Planning for Your Grandchildren’s Futures

By Chris Duderstadt

May 20, 2024

529 Plans and Planning for Your Grandchildren’s Futures

Key Points – 529 Plans and Planning for Your Grandchildren’s Futures

  • What Tax Benefits Apply with 529 Plans?
  • How the SECURE Act and SECURE 2.0 Have Impacted 529 Plans
  • The Two Different Types of 529 Plans
  • What If Your 529 Plan Is Overfunded?
  • 5-Minute Read

Supporting Your Grandchildren’s Futures with 529 Plans

Special moments always happen in a flash—especially the times you treasure with your grandchildren. One minute, they’re starting to take their first steps. Then, suddenly, they’re taking much bigger steps across a stage for high school and even college graduations. One way you can support your grandchildren as they’re growing up is to lay the foundation of their futures by setting up 529 plans. Let’s investigate some of the nuances of 529 plans, including their tax benefits.

What Is a 529 Plan?

Per the SEC, a 529 plan is “a tax-advantaged savings plan designed to encourage saving for future education costs.”1 They are legally known as “qualified tuition plans,” which are sponsored by states, state agencies, or educational institutions. 529 plans are authorized by Section 529 of the Internal Revenue Code.2

Tax Benefits of 529 Plans

If you perked up when reading “tax-advantaged savings” at the beginning of that definition, you weren’t alone. There are two types of tax benefits that come into play here.3

Federal Tax Benefits

There are federal tax benefits, as 529 plan contributions grow tax-free. Federal income tax doesn’t impact the earnings when they are taken out for the qualified education costs. There are some states that don’t follow those federal tax treatment guidelines, so make sure to check on the specific qualified expenses for your state.4

State Tax Benefits

Then, there are state tax benefits. Do you live in a state with income tax? As of 2023, only nine states—Alaska, Washington, Wyoming, Nevada, Texas, South Dakota, Texas, Tennessee, and Florida—didn’t have income tax.5 Of the states that have income tax, many of them allow a state tax credit or income deduction for 529 plan contributions whenever you’re filing your state tax return. It’s important to note that those state tax benefits are available to any 529 plan contributor in most states, so you don’t have to be the 529 plan owner to receive them.

Education Savings Plans

When it comes to 529 plans, there are prepaid tuition plans and education savings plans—the latter being more common due to their flexibility. Education savings plans allow you to start an investment account to save for your loved one’s qualified college academic expenses.6 Those expenses include tuition, obligatory fees, and room and board. However, 529 distributions are not eligible for college credits, so that is an important consideration to make when the plan beneficiary is enrolled in post-secondary education.

One of the big perks of education savings plans is that the investments grow tax-free and have tax-free withdrawals. The contributions to 529 plans are after-tax contributions, which aren’t federally tax deductible. The withdrawals from these plans are widely accepted at most colleges, both U.S. and international schools.

With the education savings plans, you can pay a maximum of $10,000 per year to help cover the beneficiary’s elementary or secondary education tuition. There is also some flexibility here when it comes to portfolio investment options, ranging from mutual funds and ETFs or a principal-protected bank product.

Rolling Over a 529 Education Savings Plan to a Roth IRA

Education savings plans operate a lot like Roth accounts due to their tax-free nature. And as of 2024, education savings plans are tied even more closely with Roth accounts. When the SECURE Act 2.0 was passed in December 2022, one provision that was included pertained to 529 education savings plans being eligible to be rolled over to a Roth IRA under certain conditions. That provision went into effect on January 1, 2024. Learn more about 529 plan Roth IRA rollovers in our article, 529 Rollover to a Roth IRA – What You Need to Know.

Being Aware of the Roth IRA Contribution Limits

For 529 education savings plans, beneficiaries can do a maximum rollover of $35,000. That rollover must occur during their lifetime and can be done from any 529 plan in their name. It’s important to keep retirement account contributions and income limits top of mind when considering doing a Roth IRA rollover from a 529 education savings plan. For 2024, the Roth IRA contribution limit is $7,000. If you’re 50 or older, that can be $8,000 with a catch-up contribution.

To take advantage of a 529 education savings plan rollover to a Roth IRA, you need to have had your 529 plan for at least 15 years. Also, funds that you contribute to the 529 education savings plan can’t be rolled over until you exceed the five-year holding period.

Why Doing a Roth IRA Rollover Could Make Sense for a 529 Plan Beneficiary

There are various reasons why doing Roth IRA rollover could make sense for the beneficiary of a 529 education savings plan. Maybe your grandchild, child, or whoever is the beneficiary of the 529 plan decides to forgo finishing college. Or your financial support could be more beneficial to them as they’re starting their career rather than during college. Those same sentiments were also expressed by Congress within Section 126 of SECURE 2.0.7

“Families who sacrifice and save in 529 accounts should not be punished with tax and penalty years later if the beneficiary has found an alternative way to pay for their education. They should be able to retain their savings and begin their retirement account on a positive note.” – SECURE 2.0, Section 126

Prepaid Tuition Plans

Let’s shift gears to 529 prepaid tuition plans and how they differ from 529 education savings plans. A prepaid tuition plan allows you to buy units/credits at certain academic institutions for future tuition for your grandchildren or whoever’s educating you are funding.8 For each unit/credit, you have the option to pay in installments or as a lump sum.

If you buy a prepaid tuition plan, it becomes the plan administrator’s responsibility to invest the money on your behalf. Then, once the beneficiary of the plan is in college, the funds transfer to that institution.

Restrictions of Prepaid Tuition Plans

Opting for the prepaid rate may offer a potential savings opportunity. Paying for college isn’t getting any cheaper due to inflation.9  However, prepaid tuition plans tend to be more restrictive than education savings plans.

First, they’re only offered to new enrollees in select states—Washington, Nevada, Texas, Michigan, Mississippi, Pennsylvania, Massachusetts, and Florida.10 If you have an existing prepaid tuition plan in another state, don’t fret. Your plan’s beneficiary will still be able to receive their benefits. There are just some states such as Illinois, Virginia, and Maryland which have closed enrollment of prepaid tuition plans to new participants. This is subject to change going forward based on each state’s guidelines on prepaid tuition plans.

Prepaid tuition plans are usually sponsored by public in-state colleges. You and your plan’s beneficiary could still be in luck, though, if they want to attend a private college that sponsor Private College 529 Plans.11 They also usually aren’t permitted for paying for future room and board for higher education institutions and don’t pertain to tuition at secondary and elementary schools.

Fees and Expenses

There is a wide range of fees and expenses with all 529 plans. It is important to note that these fees and expenses may impact your returns.

For prepaid tuition plans, you can be assessed with an enrollment fee and recurring administrative fees. For education savings plans, you could be tasked with the application fee, yearly account maintenance fees, and recurring fees for program and asset management. The collection of the fees is done by the plan manager or 529 plan’s state sponsor.

School Is in Session Year-Round for Education on 529 Plans

While school might be out for your children and grandchildren, the studying doesn’t stop for us at Modern Wealth Management. If you’re a Modern Wealth Management client and have questions about your 529 plan options, please don’t hesitate to contact your advisor.

We also welcome any questions about 529 plans from non-Modern Wealth Management clients. If you want to help your loved one’s mission to walk across the stage or set them up for financial success early in their careers, start a conversation with our team below.

Schedule a Meeting

Leaving a legacy and building generational wealth are so important to so many retirees and those who are preparing for retirement. If you have a child, grandchild, or another loved one who is working hard in the classroom, setting up a 529 plan for them is something worth considering that both of you can benefit from.

Resources Mentioned in This Article

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Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.