529 to Roth
02 Jan 2024
Massive new change to 529 Savings Plans just took effect
Not to date myself, but when I first got in the financial planning business, the only tax-favored savings plan for college was the Coverdell Education Savings Account ("Education IRA") with a maximum annual contribution limit of $500. Granted, that amount went up to $2,000 per year around the turn of the century (that does make me sound old), but considering the average cost of in-state tuition and room and board at a public college is now $24,000 per year, that seems like a drop in the bucket—even with the tax-protected growth.
Around the same time that the Education IRA contribution limit was going up, a truly remarkable college savings tool was being created by Congress: the Qualified Tuition Program, or 529 Plan. In short, each US state could operate its own version, which essentially had no contribution cap (though the annual gift tax exclusion is currently $18,000 per person), and the funds would grow tax free. Assuming the proceeds were used for qualified education expenses, even withdrawals were—and remain—tax free. As of 01 Jan 2024, the plan got even better.
Through a provision in the Secure 2.0 Act, any time after fifteen years following the Plan's initial setup, any unused portion—up to a total of $35,000—can be rolled into a tax-free Roth IRA for the beneficiary. Just for fun, we plugged $35k into our Wayback Machine, set the dial for the S&P 500 in 2014, and discovered that we now have a cool $222,000 of tax-free retirement savings. This really is a big deal.
As good as the concept of the 529 Plan has been in the past, investments have actually been on the decline recently. A lousy market return in 2022 played a role, but our biggest hangup has been the disparity in states' plans. To be blunt, some plans have simply awful, age-based options, as opposed to the freedom of choice we had with the old Education IRAs. Another drawback has been the convoluted rules with respect to the degree in which a 529 plan could affect financial aid and the expected family contribution (EFC) amount. Still, compared to the options available when saving for a kid's education, the best tool just got a lot better.
One of our arguments against the federal government attempting to pay off portions of student loans (besides our $33.8 trillion national debt) has been the fact that it disregards the most responsible savers, those who worked their way through school, and those who joined the armed services in-part for the education benefits. When student loan repayments resumed this past fall, only 60% of debt holders began making payments once again. Most of the other 40% are waiting for something magical to happen via the federal government. Odds are great they are in for an unpleasant surprise down the road.