529: Educational Savings Accounts and BIG Changes… It’s NOT just about College Anymore

Five Things You Should Know

1. Equity Markets – finished higher this week with U.S. stocks (S&P 500) rising 1.98% and international stocks (EAFE) up 1.64%   
2. Fixed Income Markets – rose this week with investment-grade bonds (AGG) up 1.85% and high yield bonds (JNK) up 1.97% 
3. New Limit – A US plan to restrict investment in China is likely to apply only to Chinese companies that get 50% or more of their revenue from sectors such as quantum computing and artificial intelligence. The provision would limit the scope of an executive order the Biden administration is expected to unveil in the coming days as part of a push to limit Chinese access to sensitive technology. The final version of the executive order, which has been more than a year in the making, is expected to be far less ambitious than the earliest versions.  
4. Property Gloom – Stocks and bonds in China’s Country Garden, which was once the nation’s biggest property developer, nose-dived after two noteholders said they did not receive the coupon payments that were due Monday. This continued negative sentiment in the crisis-stricken property sector. This company owed $10.5 million of interest on a dollar bond that matures in 2026 and $12 million on a note due 2030, according to data compiled by Bloomberg. 
5. Key Insight – Many think the 529 Educational Savings Account is just for college… NOT SO! Today we’ll dig into the benefits of the 529, how it can be used for K-12 tuition costs, potentially save on estate taxes, and set up your beneficiary with a ROTH IRA.

INSIGHTS FOR INVESTORS

by Ben Klündt

The 529 Education Savings Account used to be strictly meant for higher education expenses and one would be penalized if it was used for any other purpose, to the tune of 10% and then ordinary income tax, ugh… It was a bit of a gamble on whether you believed your kiddo was likely to be going to college or not.

That all changed six or seven years ago when they opened it up to K-12 school tuition costs and now in 2024 we have some further changes arriving. Some of these provide significant opportunities to grandparents considering their estate plans, parents looking for tax savings, and/or anyone looking to set their “student” up for success in retirement (yes, retirement) with a jump start on savings.

With the Supreme Court striking down President Biden’s “proposal” for student loan forgiveness, along with a lot of ambiguity about the direction it will truly go. This situation coupled with some changes coming regarding the filing for FAFSA (Free Application for Federal Student Aid) only aids the potential for 529 plans to aid families in finding more of the burden of educational expenses falling on their shoulders.

The “BIG THREE” potential benefits we’ll be highlighting below include:

1. 529s can be used for K-12 education expenses
2. Funding a 529 has estate benefits (e.g. it could help with estate taxes)
3. 529s ability to convert to a ROTH IRA for the beneficiary (NEW!!!)

What a 529 Covers

I’ll first highlight the change from the 529 being strictly for college expenses to include K-12 education costs (please also note most trade schools and community college costs are also eligible). This additional benefit happened with the 2017 Tax Cuts and Jobs Act which allowed for the benefit of tax deferred growth and distributions that are provided by a 529 account to also pay for K-12 education tuition costs (NOT books, supplies, and computers). Meaning you can now use a 529 to pay for private school K-12 education tuition up to $10,000 a year.

Whoever sponsors the 529 (Grandparents, Parents, Uncle/aunt, etc) technically owns the 529 account and has the option to swap the beneficiary if said beneficiary decides to go a different direction than higher education or K-12. While the sponsor of the 529 doesn’t get a tax deduction for funding the account they do get the benefit of tax deferral (like a traditional IRA) but then if used for one of the approved educational expenses, those tax-deferred gains come out as TAX FREE (like a Roth IRA.) Big win. Side note: you can use it for up to $10,000 in student loan repayments as well.

Potential Estate Benefits

The second aspect we’ll touch on is how a 529 could potentially benefit one’s estate. I know… what does a college savings account have to do with my estate?! Well, for starters, even though you may own the 529, it’s not included in your federal estate as the sponsor of the account, and you still get the benefit of access to the capital (with penalty) if needed for expenses, outside an approved educational expense for the beneficiary, and all gains are now out of the estate. You can use the annual gift exclusion of $18,000 (2024) or you can use the “Special Contribution Rule” we’ll discuss below.

529 plans offer a special gifting exclusion as well by “super-funding” the 529. You can make a lump-sum contribution to the account of up to five times the annual gift tax exclusion (so $90,000 in 2024), elect to “spread” the gift evenly over five years, and completely avoid federal gift tax, provided no other gifts are made to the same beneficiary during the five-year period. A married couple can gift up to $180,000. That $180,000 is no longer in their estate even though they may control the 529 and who the beneficiary is!

529 as a Retirement Vehicle

The third and final new aspect of 529s before, we put a bow on this super exciting commentary, is that you can now roll any unused portion of the 529 to a ROTH IRA. Folks tend to underfund the 529 because they wouldn’t know if their student would get a scholarship, aid, or just the worry of the account being overfunded, and they now had a balance in a 529 that they didn’t need any longer after school or their kid opted to not go to school. Now that portion can be rolled into a ROTH IRA for the beneficiary of the 529 up to the IRA contribution limits ($7000 for 2024) assuming they have the income to warrant it. That means if they graduate or opt to not go to school and there is excess in the account, you can roll up to $35,000 into a Roth IRA without penalty or tax.

A few stipulations come with this. As I mentioned above, the beneficiary would need to have earned income as the contribution to the ROTH IRA cannot be greater than the beneficiaries’ earnings. A second is that the account needs to have been opened for 15 years so you can’t go and “super fund” and then just convert to a ROTH IRA by putting your kids on the payroll to have earned income. (Though I like where you’re head’s at if you were thinking this.)

In Summary

So, to wrap things up, the “big three” items we wanted you bring to your attention are 1) that the 529s can now be used to pay tuition on K-12 tuition costs, 2) they can be used to help with estate taxes by getting some assets out of your estate for your heirs and lastly, 3) that you can help your loved one get started towards retirement with the new ability to fund a ROTH IRA with any excess dollars.

If you’re wondering if any of these things can benefit you or your financial plan, reach out to us, we’d be happy to chat.

Have a wonderful weekend and stay warm!

Ben Klundt and the Ten Capital Team

DATA, JUST THE DATA

U.S. Jobless Claims – fell by 19,000 to 202,000 on the week ending December 9^th, which was well below market expectations of 220,000 and marks the lowest level of new claims in two months. 

U.S. Retail Sales – increased 0.3% MoM in November 2023, unexpectedly rebounding from an upwardly revised 0.2% decrease in October. This beat market forecasts of a 0.1% decline. 

U.S. MBA Mortgage Application – surged by 7.4% in the week ending December 8^th, marking the sixth consecutive period of increase and led new applications to the highest level in over four months, much due to the continuous decline in interest rates. 

UK Composite PMI – rose to 51.7 in December 2023 from 50.7 in the previous month which surpassed the market consensus of 50.9. This latest reading indicated the fastest pace of expansion in private sector business activity since June.