The ABC’s of Section 529 college savings plans

Recently, someone asked about saving for a grandchild’s college expenses but was hesitant to start because of a concern about what would happen if the child didn’t use the money. This reluctance to save is understandable if you’re concerned about essentially “saving money for nothing” but fortunately there are a number of exit strategies for unused money in a college savings plan (i.e. 529 Plans).

The basics of savings for college expenses

Before outlining the various options for unused money, let’s review the basics of saving for college expenses. While there are several viable options for saving including custodial brokerage accounts, U.S. savings bonds, Coverdell Education Savings Accounts and even Roth IRAs, typically the simplest choice is the Section 529 College Savings Plans. Specifically designed to accumulate money potentially tax-free, 529 Plans offer a number of attractive features including:

• low minimum contribution to start (as low as $25 for the Wisconsin Edvest Plan)
• Variety of investment options for growth
• Potential state income tax deduction for contributions

For 2024, the maximum tax deduction for most Wisconsin taxpayers is $5,000 (which is significantly higher than previous years) so not only will the earnings be tax-free upon withdrawal for qualified expenses but the person making the contribution can potentially get a tax deduction upfront too! While you can customize the investments within the account (with a limit of two exchanges per year), the simplest option is to select the “enrollment year” option which automatically reduces the stock allocation as the child gets closer to college age.

Options for using the funds

When it’s time to withdraw money, you have several options for using the 529 college savings plan funds beyond tuition at four-year universities including:

• up to $10,000 per year of the money for K-12 tuition expenses
• principal & interest on student loans for up to $10,000 per beneficiary
• tuition at technical schools and/or community colleges (as long as they’re considered “eligible educational institutions”)
• Room & board expenses if the beneficiary is at least half-time at a postsecondary school

Leftover money in the account

Although each state typically has their own 529 plan, the money can be for used out of state colleges too. Even with the broad options for using money, there’s still a chance you might have leftover money in the account which was the original concern for this article. In this case, you have several options including:

• Leave the money in the account in case the beneficiary needs it for additional education expenses (e.g. graduate school) since there’s no requirement to withdraw by a certain age
• Change the beneficiary to another family member
• Use the money for Roth IRA contributions
• Withdraw unused money with tax & penalty on just the earnings with a waiver for the penalty if the withdrawal is offset with scholarships or other tax benefits (such as claiming the American Opportunity Tax Credit)

Using excess money for Roth IRA contributions

Using the excess money for Roth IRA contributions is a new option starting in 2024 (which also means there’s still some uncertainty how it will work exactly). According to www.Edvest.com, there are a number of qualifications to discourage abuse including:

• The 529 plan account must be open for 15 or more years, ending with the date of the rollover
• Contributions and associated earnings that you transfer to the Roth IRA must be in the 529 plan account for more than five (5) years, ending with the date of the rollover
• Lifetime maximum rollover amount of $35,000 per beneficiary
• 529 plan assets can only be rolled over into a Roth IRA for the benefit of the beneficiary on the 529 plan account
• 529 plan assets must be sent directly to the Roth IRA
• Roth IRA income limitations are waived for 529 plan rollovers to Roth IRAs
• The Roth IRA contribution is subject to the annual Roth IRA contribution limit ($7,000 for 2024)
• The beneficiary must have earned income in order to make the rollover (similar to existing Roth IRA contribution rules)

While it may seem complicated at first glance, the flexibility with using 529 plans for education could potentially save you thousands of dollars of income taxes which makes them a useful tool to consider. To learn more about the Wisconsin plan, visit www.edvest.com or www.savingforcollege.com for information on other states’ plans.