New regulation makes savings plans for universities even better

Before we talk about 529 plans, let me first explain that I am a big fan of these plans. In the financial services industry, these plans receive significant attention from regulators and require a lengthy disclosure, which will surely be listed at the end of this column.

The reason for this is that the topic can be quite complicated as each state has its own plan with different tax benefits for its residents. Add to this the different prices in the plans, some with sales markups and some direct investment plans without sales markups, and it is understandable why families are confused and regulators are taking interest. Given the possibility that you may choose a less-than-ideal government plan and cost structure, the potential for errors and poor sales practices is not insignificant.

When I write about 529s in this column, I usually refer specifically to the Indiana College Choice 529 plan, although some comments may apply to all plans. Indiana also has two different pricing options for its plan: a sales load-based plan used by commission-paid investment representatives and a direct no-load plan for direct purchase by investors and for use by fiduciary investment advisors. Both plans are branded “College Choice,” offer identical tax benefits, and are very similar in structure.

I’m such a big fan of these plans for two reasons. The main reason for this is that I have a lot of experience with families, including my own, and use these plans with great success. I personally started investing $25 a month in my oldest daughter’s plan when she was just a little baby, before I could even afford it, and by the time she got to Purdue the plan had grown significantly and was almost covering it 60% of their tuition costs through growth alone. Long-term exposure to the stock market, combined with regular savings and patience, can be a powerful planning tool. I have observed this trend with many customer families over the years.

The second reason is the tax advantages, particularly our tax advantages in Indiana. The state of Indiana offers a 20% tax credit of up to $1,500 that can be used to directly pay off the investor’s state tax liability. That means if a family owes $3,000 in Indiana state taxes, maximizing the credit would reduce their state tax burden by $1,500. In my opinion, Indiana offers one of the most attractive tax advantages in the country. All 529 sovereign funds grow tax-deferred and distribute tax-free when used for education expenses.

Additionally, due to other recent rule changes, parents and grandparents can now both contribute to a single 529 account and both claim the funds, making the savings process even easier for the family. Of course, college planning can get complicated as the child becomes a young adult and concerns about financial aid and other issues. I therefore still recommend seeking professional advice before deciding to finance these plans.

So yes, I really like this planning tool, but there wasn’t a good answer to the question we started with. If, before 2024, the child named as a beneficiary of the plan either decides not to continue his or her education at an accredited institution or, on the other hand, receives a full-ride scholarship and ends up not having to pay educational costs out of pocket, the options would be to change the beneficiary of the plan to another In this case, if the person were to convert the person or distribute the funds, the winnings would be taxed and there would be an additional 10% federal tax penalty, which wasn’t great.

However, thanks to the Secure Act 2.0 passed in late 2022, the government now allows funds in a 529 plan to be rolled over to a Roth IRA for the benefit of the child without taxes or penalties. There are a few stipulations to this rule: the 529 must have been established for at least 15 years to qualify, transfers are limited to the annual Roth IRA contribution limit (currently $7,000), and the total amount of value transferred to the 529 the Roth cannot exceed $35,000. So if we do the simple math, it would take around five years for the full transfer to be implemented, but this could really help boost the young person’s pension building process and I think this new option is quite attractive.

In my experience, the key to the success of these plans lies in the time value of money, meaning the sooner savings begin, the higher the likelihood of success. So when you gush over the baby in the crib and wonder what the future holds, not everyone is going to college, everyone is going to retire at some point. Now, a 529 savings plan can potentially help with both.