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Rules changing on educational savings accounts

3 min read
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New rules governing 529 educational savings plans are coming in 2024.

A 529 education savings plan is a tax-favored program operated by a state and is designed to help families save for future education costs. While the fees, expenses and features of these plans vary from state to state, as long as a plan satisfies the requirements of section 529 of the Internal Revenue Code, federal tax law provides tax benefits for both the contributor and the beneficiary. A 529 plan can be opened for the benefit of anyone by anyone.

In Pennsylvania, state income tax deductions for 529 contributions are available to any Pennsylvania taxpayer. Although a contribution to a 529 plan is not an income tax deduction, earnings in a 529 plan grow federal tax-free and are not taxed upon withdrawal to pay for certain college and other qualified education expenses.

The Secure 2.0 Act, a 2022 law that affects many retirement plans, allows excess funds in these education savings plans to be rolled over into Roth IRAs tax-free if the Roth belongs to the beneficiary of the 529. Previously, if leftover funds were withdrawn and not used for qualified educational expenses, the 529 owner would owe income tax on the earnings portion of the withdrawal and a 10% penalty would be imposed.

Excess funds, or money left over, in a 529 could be the result of a child winning a scholarship, attending a military academy or deciding not to pursue higher education. The risk of unused money languishing in a 529 plan causes some families to fund their plans conservatively or to not open an account.

The rule change increases the ability of young people to save for retirement. The new rules require the Roth IRA to be set up in the name of the beneficiary, not the owner of the 529 account. There also is a lifetime maximum amount, $35,000, that can be transferred to the Roth from the 529.

Another restriction: The 529 plan must have been open for more than 15 years, and rollover funds cannot include any contributions to the 529 account and earnings on those contributions made in the previous five years. Rollovers are subject to the annual Roth IRA contribution limit. The limit in 2024 has not yet been announced, but the limit this year is $6,500. So it would take a number of years before one is able to take full advantage of the $35,000 rollover allowance. The 529 plan beneficiary must have compensation in the year of the rollover at least equal to the amount transferred.

As I have explained in other articles on Roth IRAs, contributions are not tax deductible, but all withdrawals after age 59 1/2 are federal tax-free.

So in a real life situation your beneficiary at age 22 could roll over $6,500 for five years. If left to grow at 8%, that $32,500 could grow to $643,106 in 38 years.

If you have been hesitant to open a 529 plan for your children, these rule changes make the plan more palatable. The 529 plans are sold directly through the state or through licensed financial advisers who work for a broker dealer or registered investment adviser.

Bob Hollick is a State Farm Insurance agent based in Washington. His column appears every other Friday in the ObserverReporter. Questions may be emailed to Bob@bobhollick.com.

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