The 529 Plan: Overkill or College Savior?

How exciting!

A newsletter revolving around the IRS!

As parents plan for their littles to attend college one day, they can invest in an account that offers tax-free earnings upon withdrawal for college expenses.

But how much is too much? What if my kid gets a full ride? What if my kid attends a vocational school? And why is the 529 plan in the news? Well, glad you asked…

The 529: A History

The 529 plan is designed to help families save for children's education expenses. It was named after section 529 of the Internal Revenue Code - how original!

In the 1980s, the Michigan Education Trust (MET) established a prepaid tuition plan. A few years later, Section 529 was added to the Internal Revenue Code, authorizing tax-free status for qualified tuition programs.

The original plans were created by a few states, with the remaining falling in line. Since its inception, twelve million families have saved more than $258 billion in 529s.

College Ain’t Getting Cheaper

According to the College Savings Plans Network, the average 529 plan balance hit a record $25,664 as of June 30, 2020. That’s great! Or is that SCARY?

I’ll go with scary because the average tuition cost in America for an in-state public school is now above $10,000 per year. Out-of-state? Almost $23,000. Private? Hello, $40,000!

This means if no scholarship is considered, your kid can only afford 25% of college tuition - FOR THE FIRST YEAR. Forget about years 2-4.

So college is expensive and getting more expensive. Why should I stash away money now?

Tax benefits!

Contributions to a 529 plan are made with after-tax dollars, but the earnings on the account grow tax-free. Some states even offer tax deductions for your contributions! It’s an investment account with risk, so the value can fluctuate based on market conditions. But if invested early on, the value can increase significantly, and provide a family with a nice cushion to afford the ongoing increase in college costs.

529s are sponsored by states, and offer a range of investment options. They provide greater flexibility than prepaid tuition plans and can be used at any accredited college or university in the US. The account owner can change the beneficiary of the account at any time, which means that if one child decides not to attend college, the funds can be used for another child or family member.

Withdrawals from the account are tax-free if they’re used to pay for qualified higher education expenses.

For example, at birth, let’s contribute $5,000 initially to our imaginary child. We contribute $100 per month, and assume 5% annual return. Once they reach college age, we contributed over $26,000, but earned a staggering $20,000!

Time is the ultimate asset.

The Conversion Factor

NEWSFLASH: In 2024, any unused amount of the 529 can be rolled into a Roth IRA for the beneficiary, tax-free and penalty-free! This is huge news for parents who obviously don’t know where their kids will attend school and how much it will cost.

There’s a lifetime limit of $35,000 and the annual contribution limits still apply (currently $6,500). If you did the max, it would take approximately 5.5 years to transfer all the assets to the Roth.

Why would I want to deal with this headache?

Well, you're setting your child up for success. Or at least, providing a financial boon for future years.

Fidelity has a worthwhile resource to check out. If an individual anticipates retiring in 40 years, transfers their $30,000 529 assets into a Roth, and attains a 7% rate of return, they’re looking at approximately $450,000 at retirement.

TAX-FREE.

A 529 plan is a great tool for families. Set up at birth, and contributed to for years, can provide an enormous relief to a high school grad - and their parents!

And even if college isn’t in the plans, rolling it into a Roth is another safety net for everyday expenses down the road.

Way down the road!

Save On,

Chris