You may have noticed, it has been a while since I posted. I’ve been pulled in many different directions the past few weeks between work travel, personal travel, and recently accepting a new day job! In addition to everything else I’ve done in the past month, I also finally opened a 529 account!
As someone who is not planning to have kids–for many reasons–I was very slow to get on the 529 train. I get it now. Let me explain.
A 529 account is a tax-advantaged savings account for education purposes funded with post-tax money. The conditions of “education purposes” seem pretty generous, and you can even use your 529 funds to cover living expenses while you’re in school. While 529 accounts can’t be invested like a standard brokerage account, the account will have a selection of pre-designed plans to choose. Usually the plans are based on the level of risk you’re prepared to tolerate.
Most, if not all states, and major brokerages offer 529 accounts. Though state-managed 529 accounts may offer additional tax advantages for annual contributions. Most importantly, compound interest earned from 529 accounts can be withdrawn for education expenses, in most cases, exempt from federal and state income tax.
They’re more or less like Roth Individual Retirement Account (IRA) accounts, but for education expenses.
Who are 529 Accounts For?
Most of the time, 529 accounts are marketed to support your child’s education cost. I don’t know who can afford to pay for their child’s college education–perhaps those who started 529 plans years ago–but there are so many more benefits.
My big revelation was learning last month that the account holder can name any beneficiary to their 529 account—including themselves! Moreover, the account holder can change the beneficiary at any time, according to the U.S. Securities and Exchange Commission (SEC).
Perhaps you’re thinking, “I’m so done with school. Why would I want to spend a single more cent paying to learn?” I get that. Perhaps things may change in the future, perhaps you do have children, perhaps someone close to you will need some support to achieve their education goals. Perhaps you exhaust your GI Bill benefits, or perhaps you were unable to transfer your GI Bill benefits to a dependent because you didn’t know, and therefore didn’t fulfill, the stringent requirements to transfer your GI Bill benefits. To learn now, read my 5 Essential GI Bill Transfer Requirements.
Perhaps you open a 529 account, but never use the funds. Fortunately, with several conditions, you can rollover your 529 funds into your IRA.
Rolling 529 Funds into an IRA
An amazing benefit to the 529 account is, if you don’t use the funds for education, you can move those 529 funds into your Roth IRA. There are several restrictions to keep in mind–I’ll go over in more detail below. Long story short though, this is an excellent tax advantaged account, where you can contribute post-tax money and let the funds grow tax-free. You can then use it for education, pay off up to $10,000 in existing student loans, and/or roll up to $35,000 into an IRA if you don’t decide to use it or gift it.
What Exactly is a 529 Account?
529 funds can be used on qualifying education expenses including tuition, mandatory fees and room and board at most colleges and universities for the beneficiary. What’s more, is up to $10,000 can be used to pay off existing student loans. And, if you’ve decided to enroll your children in private grade schools, up to $10,000 can be used toward tuition at elementary or secondary schools per year, per student.
You can change the beneficiary at any time with no tax penalties.
According to the SEC, withdrawals used for education expenses are not subject to federal income tax–this includes any account earnings. Usually states also do not charge tax on 529 account earnings when the withdrawals are made toward qualifying education expenses. However, it should be noted that withdrawals not used for education purposes are subject to federal income tax, state income tax, and a 10% federal tax penalty.
What About Unused 529 Funds?
If you have education plans for your or a beneficiary in the future, then 529 plans are an excellent way to set some money aside and reap tax-free earnings. Those earnings are maximized, of course, the longer the funds are left in the 529 account to grow.
However, what happens if you never use the money in the account? 529 accounts have a unique feature where unused 529 funds can be rolled over into the Roth IRA account of the same 529 beneficiary.
This means, if you open a 529 account for yourself, and if you don’t use the funds for education, you can roll remaining funds into your Roth IRA. There are many restrictions to completing this rollover, detailed below. However, this can be an excellent out if you find your education plans change.
First, though, you need to have a Roth IRA account to roll those funds into.
What is an IRA?
Just so we’re starting on the same page, an IRA is an Individual Retirement Account with major tax advantages. Unlike the 401K, an IRA is not managed by your employer. As its name suggests, it’s your personal account which you can fund and manage directly.
You can open an IRA any time online at any of the major brokerages. My IRA happens to be through Charles Schwab, but I also recommend Vanguard because of their customer-focused, low fee business model.
Like 401K accounts, you can open a Traditional or Roth IRA. Funds you contribute to a Traditional IRA lower your taxable income for that year, reaping tax advantages today. Funds you contribute to a Roth IRA are subject to state and income tax today, but compound interest can grow and be withdrawn tax free. If you’ve read my post Compound Interest: The good, the bad, and absolutely marvelous, you know that after just 20 years of consistent investing, over half of your total portfolio will be compound interest. If you invested in a Roth IRA, that 50% compound interest can be withdrawn tax free. For this reason, I’m obviously biased toward Roth anything, but that’s for another post.
The point is an IRA is an excellent account for your investing portfolio. In 2023, the maximum IRA contribution limit was $6,500–this is the total cap toward your combined IRA contributions, say, if you have multiple IRAs. This may seem low, but perhaps that’s because the 401K contribution limit is considerably higher at $22,500 for 2023.
Restrictions to Converting your 529 into Your IRA
While the ability to roll your 529 funds into your IRA is an awesome alternative if you decide to not use your 529 for education, there are SEVERAL restrictions to plan around:
- The 529 account must have been open for 15 years prior to transferring any funds from your 529 account to your IRA.
- Any transferred funds have been in that account for 5 years.
- Any funds you move to the IRA from your 529 account still count toward your annual IRA limit.
- Total rollover limit is $35,000.
A Note About Insured Accounts
It should be noted that not all 529 accounts are FDIC insured. So, double check if your account will be FDIC insured. However, this is more for your situational awareness rather than a determining factor. After all, it is an investment fund, which are not typically insured by the FDIC anyway.
Conclusion
While 529 accounts are usually advertised to support funding your child’s education, they have several broader applications. Most notable, you can use it to fund your own education, pay of existing student loans, fund your child’s primary and secondary school tuition, and even be rolled over into the beneficiary’s IRA. As always, consult a financial advisor so you understand the restrictions on all of these money moves, but don’t underestimate the tax advantages of these versatile accounts!
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