Saving for the High Cost of College: Understanding 529 Plans

Nearly every dermatologist with children or grandchildren lists saving for these family members’ college education as one element of their long-term financial plan. Certainly, this is to be commended—not only because of the value of higher education, but also because college and graduate school tuition costs have outpaced inflation for years. Many dermatologists incorporate a college savings plan to help achieve this financial goal. This article examines 529 plans, the most popular type of college savings vehicle.

529 Plans

Named after Section 529 of the Internal Revenue Code, 529 plans are state-sponsored, tax-advantaged savings accounts designed to help families and individuals save for future education expenses.

There are 2 main types of 529 plans, as follows:

1. 529 prepaid tuition plans: These plans allow you to prepay tuition at today's rates for use when your beneficiary (the student) attends a participating college or university. This can be a good option to lock in tuition costs and hedge against future increases.
2. 529 savings plans: These investment accounts allow you to save for education expenses such as tuition, fees, books, supplies, and even certain room and board costs. The money you contribute to a 529 savings plan is invested in various investment options, typically including mutual funds or similar investment vehicles. The earnings on these investments can grow tax-free, as long as they are used for qualified education expenses.

529 Plan Basics

• Tax benefits: Contributions to 529 savings plans are not federally tax-deductible, but the earnings grow tax-free if used for qualified education expenses. Many states also offer state income tax deductions or credits for contributions to their own state's 529 plan.
• Qualified expenses: Qualified education expenses can include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. Up to $10,000 per year per beneficiary can be used for tuition expenses for kindergarten through 12th grade.
• Flexibility: 529 plans offer flexibility in terms of changing beneficiaries. If one child doesn't use all the funds, you can often change the beneficiary to another eligible family member without incurring penalties.
• Contributions: While there are maximum limits to how much you can contribute to a 529 plan, these limits are generally quite high, often exceeding $300,000 or more, depending on the state.

529 plans have been great educational tools to help families save money for college and use that money, tax-free, to pay for college expenses. While the plans are still relatively young, they continue to be adapted and provide new benefits as their popularity increases.

New solution for 529 plans offers added flexibility

We often hear from parents and grandparents about the rigid rules for qualified distributions from 529 plans. Many worry that funds will be stranded in 529 plans when their children or grandchildren don’t use them.

While 529 funds are supposed to be earmarked for education expenses, the new Roth IRA transfer provision provides a workaround for balances that aren’t being used for educational purposes. Without this provision, the growing, unused funds would be taxed at the investor’s income tax rate—and if the funds were used for ineligible expenses, the money would be subject to a 10% tax penalty.

Beginning in 2024, taxpayers with 529 plan balances can transfer those balances to Roth IRAs. However, this provision comes with many rules and restrictions, including the following:

• A lifetime maximum of $35,000 can be rolled over from a 529 plan to a beneficiary’s Roth IRA.
• Annual Roth IRA contribution limits apply to rollovers (in 2025, the limit is $7000, which means it would take 5 years to convert $35,000 from a 529 plan to a Roth IRA).
• Because the annual transfer amount is subject to the IRA limit, the beneficiary must have compensation.
• Conversions can only be made to a beneficiary’s Roth IRA. A parent saving with a 529 plan in a child's name cannot convert unused funds back into their retirement account.
• Rollovers are prohibited until a 529 account has been open for at least 15 years.
• Contributions to the 529 plan made within the previous 5 years (and the earnings from those contributions) are not eligible to be transferred.

This new rule helps families who have set aside funds in 529 plans avoid taxes and penalties if the beneficiary finds an alternative way to pay for higher education. Because the Roth IRA income limits ($153,000 for single filers and $228,000 for joint filers in 2023) do not apply to this transaction, even high-income investors who have been held back from creating Roth IRAs could do so using the 529 plan transfer.

Roth IRAs are great planning tools for a variety of reasons, including the following:

• Growth is tax-free for qualified distributions (generally at age 59½ and after a 5-year holding period).
• There are no required minimum distributions (RMDs) at age 73 or older. Note that the SECURE 2.0 Act changes the RMD age to 73, and eventually to 75.
• Growth can continue for 10 years beyond the death of the Roth owner and spouse (if the spouse is the beneficiary).

With careful planning and an early start on saving, 529 plans make excellent tax-efficient college savings options. They allow you to harness the incredible power of compounding interest to help your child or grandchild achieve their higher education goals. The added flexibility with 529-to-Roth conversions makes these plans an even more attractive tool for achieving education and retirement goals.

Conclusion

529 plans are powerful tools that dermatologists can use to save for their children’s or grandchildren’s higher education. While these plans offer tax advantages and flexibility, navigating their complexities can be challenging. Working with a financial adviser ensures that parents and grandparents can effectively incorporate the right 529 strategy into their financial planning, maximizing plan benefits and achieving their education funding and retirement goals. This professional guidance is invaluable in making informed decisions and securing a brighter future for their loved ones.

David Mandell, JD, MBA, is an attorney and author of more than a dozen books for doctors. He is a partner in the wealth management firm OJM Group (www.ojmgroup.com), where Bob Peelman, CFP, is a partner and director of wealth advisors. They can be reached at 877-656-4362 or mandell@ojmgroup.com.

Disclosure:

OJM Group, LLC. (“OJM”) is an SEC registered investment adviser with its principal place of business in the State of Ohio. SEC registration does not constitute an endorsement of OJM by the SEC nor does it indicate that OJM has attained a particular level of skill or ability. OJM and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisers by those states in which OJM maintains clients. OJM may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. For information about OJM, please visit http://adviserinfo.sec.gov/ or contact us at (877) 656-4362.

This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice, or as a recommendation of any particular security or strategy. Investment involves risk and possible loss of principal capital. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.