What I’m Telling My Clients About 529 Plans

A key component in many of our client’s long-term planning is the 529 plan, a tax-advantaged savings plan designed to encourage saving for future education costs. With recent changes in tax laws and shifts in higher education trends, I’m frequently asked whether investing in 529 plans still makes sense.

Key Takeaways

• 529 plans offer tax-deferred growth and tax-free withdrawals for qualified education expenses
• While saving for education is crucial, maintaining focus on retirement savings is equally important.
• Opting for a 529 savings plan over prepaid tuition plans provides more flexibility in terms of eligible educational institutions and investment options.

Understanding the Basics of 529 Plans

First, it’s important to revisit what makes 529 plans appealing. These plans offer significant tax advantages, including tax-deferred growth and tax-free withdrawals when the funds are used for qualified education expenses. Additionally, many states offer tax deductions or credits for contributions to a 529 plan, which can further enhance the tax benefits.

Over the past few decades, tuition and fees at higher education institutions have risen sharply, often outpacing inflation and wage growth. This increase has led to higher student debt burdens, making the financial aspect of college a pivotal factor in educational planning. And while there has been some tuition stabilization in recent years, paying college tuition for children and grandchildren remains one of the most common investor goals.

What I’m Telling My Clients

Key Considerations for Education Savings

The first and most important thing to remember is that your child can always receive financial aid or take out loans to pay for college, but there’s no such option for retirement. Postponing retirement savings means missing out on decades of tax-deferred compound growth, and it may be hard to catch up later. However, starting this year, up to $35,000 of leftover funds in a 529 account can be rolled over into a Roth individual retirement account (IRA).

Important

Starting this year, up to $35,000 of leftover funds in a 529 account can be rolled over into a Roth individual retirement account (IRA). However, be mindful of the limitations.

Before you get excited about this being a loophole to exploit, there are several requirements and limitations. For starters, a 529 rollover counts towards and is subject to your annual Roth IRA contribution limit of $7,000 in 2024 ($8,000 for individuals age 50 or older).

In addition, the 529 account must have been open for more than 15 years, and the eligible rollover amount must have been in the 529 account for at least five years. Finally, rollovers can only be made to the Roth IRA account owned by the named 529 account beneficiary. Despite the limitations, this added flexibility is a great new feature for people with overfunded 529 plans.

In terms of how much you actually need to save for college expenses, I advise my clients that you don’t need to save 100 percent of your children’s college expenses by the time they graduate from high school. I suggest that clients target to save no more than 70 percent of the estimated cost of tuition in advance and use current-year earnings to cover any remaining costs. Keep this in mind as you think about how much to save for college in a 529 plan.

Choosing the Right 529 Plan

If you opt to use a 529 plan, there are two types: savings plans and prepaid tuition plans. We’ve been discussing a 529 savings plan, an individual account. The less common 529 prepaid tuition plan is typically avoided because of its lack of flexibility. 

With a 529 prepaid tuition plan, you purchase college tuition credits at today’s prices for future use at a limited group of in-state public colleges from your state of residence. That means you may not realize the full value of these credits if you attend a private or out-of-state public school, receive a scholarship, attend a lower-cost community college, or do not attend college at all.

Warning

The credits also come with age limitations and restrictions on changing beneficiaries. Even worse, prepaid plans cannot be used to pay for room and board, computers, or books.

The Bottom Line

When discussing whether a 529 plan makes sense for a client, it’s crucial to consider their specific financial situation, goals, and the educational aspirations of their beneficiaries. For clients who anticipate their children or grandchildren will pursue some form of post-secondary education, a 529 plan remains a valuable tool. 

Read the original article on Investopedia.