Created in 1996, Section 529 plans – named after section 529 of the Internal Revenue Code – have become one of the most popular ways to save for education expenses. These plans offer numerous tax advantages. Most notably, earnings in a participant’s account grow tax-deferred. To the extent that distributions from the plan are used for qualified education expenses, the earnings are ultimately tax-free. Some states offer additional benefits which can include income tax deductions or credits for 529 plan contributions and/or limited matching contributions to a participant’s account.
If you are a 529 beginner, Saving for College offers a great primer titled What Is a 529 Plan?
There has been a lot of buzz lately about some key changes impacting 529 accounts. We will delve into those changes here.
FAFSA Simplification
Families applying for financial assistance for college will be familiar with The Free Application for Federal Student Aid or FAFSA form. The dreaded FAFSA is required to apply for federal student aid and is the starting point for many colleges that award their own need-based financial aid. Historically the FAFSA application required a lengthy reporting of parent/student assets and income, but it has been significantly streamlined starting with applications for the 2024-25 academic year.
One of the favorable outcomes of this simplification is a change in the treatment of grandparent-owned 529 accounts. Due to differing treatment of 529 accounts owned by parents vs. grandparents, the prevailing advice for years has been that parents should own 529 accounts.
- A parent-owned 529 account is included as a parent asset on the FAFSA reducing aid eligibility by a maximum of 5.64%. Distributions from the account are ignored.
- A grandparent-owned 529 is excluded from assets reported on the FAFSA. While distributions were previously treated as student income and could reduce eligibility for aid by up to 50% of the amount distributed, they are now disregarded under the new FAFSA
In simple terms – under the old FAFSA rules, parent-owned 529 accounts (parent assets) impacted financial aid eligibility a little, and distributions from grandparent-owned 529 accounts (student income) counted against financial aid eligibility a lot.
Since the simplified Federal student aid calculation now disregards distributions from grandparent-owned accounts, the key disadvantage of grandparent-owned accounts has been eliminated.
Reduction in Eligibility for Financial Aid
| Parent 529 | Grandparent 529 | |||
| Account Value | Distributions | Account Value | Distributions | |
| Old | Max 5.64% of Account Value | Ignored | Ignored | Max 50% of distributions |
| New | Max 5.64 % of Account Value | Ignored | Ignored | Ignored |
Given that the revised FAFSA ignores grandparent 529 account balances and distributions, is a grandparent 529 now preferable to a parent-owned account? Well technically, yes, but stay tuned! Many colleges require the CSS Profile or their own financial aid form which still include questions about grandparent-owned 529 distributions. It is unclear whether these colleges will change their calculations to align with the treatment under the new FAFSA.
529 Rollover to a Roth IRA
Have a 529 account with remaining funds after all education expenses have been paid for? While you can distribute the remaining balance, the earnings portion of a distribution is subject to tax and a 10% penalty if it is not used for qualified education expenses. You have always had options such as transferring the balance to another beneficiary or using it to pay a limited amount of education loans for the beneficiary and their siblings. (See this great article at Saving for College – 6 Ways to Spend Unused 529 Fund (Without Incurring Penalties)) There is now a new tool in the toolbox – conversion to a Roth IRA.
Starting in 2024, certain account holders can transfer up to $35,000 Federal tax-and-penalty-free into a Roth IRA owned by the 529 account beneficiary. (State tax treatment may vary. Massachusetts does not follow Federal law in this instance.) The amount that can be transferred annually is subject to the Roth IRA maximum for the year (currently the minimum of $7,000 or the beneficiary’s earned income for the year).
Following are the requirements to be eligible for this rollover opportunity:
- The 529 account must have existed for at least 15 years.
- Contributions (and associated earnings) are eligible for rollover after they have been in the account for at least five years.
As with most new tax provisions, the 529-to-Roth rollover rules leave many unanswered questions such as:
- If you rollover a 529 account from one custodian to another, does this restart the 15-year clock?
- Ditto if you change the 529 account beneficiary.
- Can you change the beneficiary of a long-standing 529 to yourself and rollover funds to your own Roth IRA?
We will be keeping abreast of the legislative interpretations as they unfold for this new and exciting 529 opportunity, and we will provide additional updates as they become available.
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Bartley Financial has an experienced team of CPAs and CFPs® (Certified Financial Planners®) dedicated to helping clients manage their investment portfolios, plan for retirement, strategize taxes, or execute any other initiatives in pursuit of optimum financial health and minimal financial stress. From our offices in Andover, MA, and Bedford, NH, we work to ease clients’ financial concerns, strengthen their portfolios, and assuage their worry that they don’t know what they don’t know. Contact us today to begin a relationship with a team of knowledgeable, trustworthy professionals who put their clients first.
By Joanne Tackes
Joanne is a Certified Public Accountant and Financial Planner on our team who believes that no financial decision should be made without knowledge of the tax consequences. Her methodical approach to financial planning leaves no stone unturned as she works diligently to provide you with a comprehensive financial plan.
