As a parent or grandparent, you may have diligently saved money in a 529 account to help fund your child’s or grandchild’s college education.
But what happens if they decide college isn’t the right path for them? It’s a valid question that many families are facing as more and more people choose alternatives to traditional four-year colleges.
It’s a more common situation than you might think. Fewer students are going to college, and the expenses continue to climb. According to the Pew Research Center, American undergraduate enrollment rates peaked in 2010 and have steadily declined since. However, college costs have actually risen more than 12% over the same period.
A 529 plan is a college savings plan that allows individuals to save for college on a tax-advantaged basis. However, the tax treatment of 529 accounts is only one factor to consider before committing to this type of savings plan. You should also consider the expenses, rules, and investment options associated with a particular plan.
Colorado provides a (limited) state income tax deduction for contributions made – but not all states do. State tax laws and treatment vary, and state tax laws don’t always mirror federal tax laws. Earnings on nonqualified distributions from 529 plans are subject to income tax and a 10% federal penalty.
First and foremost, it’s important to remember that having a 529 account doesn’t mean that the funds are reserved only for a four-year college education. Several choices are available for using the money that’s been saved in the account.
One option is to use the funds for a two-year program, such as an associate degree or trade school. Many vocational schools offer programs that can lead to careers that don’t require a four-year degree. When you use the funds in a 529 account for these programs, you’re still investing in your student’s future and providing them with valuable skills that may help them succeed.
Another option is to use the funds for education expenses outside the United States. Many countries have educational institutions that offer programs that may interest your child or grandchild. By using the funds in a 529 account, you can help support their academic goals, no matter where they choose to pursue them. Certain restrictions do apply, so you will need to explore this option more thoroughly if you decide to pursue it.
In some states (not Colorado), the rules for 529 accounts allow paying up to $10,000 per year in tuition expenses at elementary, middle, or secondary schools. Furthermore, a lifetime maximum of up to $10,000 of 529 assets can repay existing student loans. If your student doesn’t use his or her 529 plan, it could potentially be used by a different beneficiary. You could transfer the funds to another family member who is preparing to attend college, or you might even decide to use the funds for your own educational pursuits.
As part of 2022’s SECURE Act 2.0, which goes into effect in 2024, a 529 account holder can transfer money to a Roth IRA account under the following conditions:
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The 529 plan must have been open for the student beneficiary for a minimum of 15 years.
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The owner of the Roth IRA must be the student beneficiary of the 529 plan.
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Any money moved from a 529 plan into a Roth IRA account will be subject to the Roth IRA annual contribution limits.
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The lifetime limit for these types of transfers is currently $35,000.
To qualify for the tax-free and penalty-free withdrawal of earnings from a Roth IRA, the distributions must meet a five-year holding period requirement and occur after age 59½. Tax-free and penalty-free withdrawals can also be taken under other circumstances, such as the owner’s death. Unlike Traditional IRAs, the original Roth IRA owner is not required to take minimum annual withdrawals.
It’s important to note that taking the money out of a 529 account for nonqualified expenses comes at a cost. Doing so is likely to result in federal income taxes and a 10% penalty on the earnings portion of the withdrawal.
The truth of the matter is that college does not offer what some young adults need. A person who aspires to enter a creative field might find more value in a vocational school or through smaller classes or institutes of learning. While most universities and colleges offer these courses, the costs involved could be problematic, as might the requirement to take courses beyond the student’s chosen field to earn a full degree. In short, college is not for everyone.
As you guide the student(s) in your life through these complicated decisions, it’s important to remember that a 529 account does provide a great deal of versatility in addition to its well-known tax advantages. The funds in a 529 account can help a student achieve their educational goals almost regardless of their path. By understanding how the chosen 529 plan works, you can maximize the benefit that the student derives from the funds and help set them up for success.
Originally published in the Aspen Times, December 23, 2023.
This column is general information, not individualized investment, tax or legal advice. Figures and rules were current when it was written and may have changed. Past performance does not guarantee future results, and all investing involves risk of loss.