Preparing for the future: How 529 plans have expanded in the past decade

Even though 529 plans have been around for decades, did you know the types of expenses you can use them for have recently been expanded? Let’s take a look at which 529 plan expenses have become qualified expenses in the past decade.

Laptops and software. In 2015, the eligible expense menu for 529s was expanded to include the purchase of computer or peripheral equipment, computer software, or internet access and related services. This equipment must be intended to be used while attending college.

K–12 tuition. The Tax Cuts and Jobs Act of 2017 made sweeping changes to the tax code. Within the TCJA’s expansive provisions was a key expansion to the list of acceptable 529 expenditures: the ability to use funds for K–12 tuition. There are two important caveats to be aware of, however:

1. While most other 529 expenses related to higher education have broad application, the law specifically limits K–12 expenses to tuition; items such as school supplies are excluded.
2. Various states have elected not to adopt the federal definition of “qualified educational expense” when it relates to K–12; therefore, 529 owners should be careful to check their state’s position on 529 expenditures and whether the expenditure could be subject to state tax.

ABLE rollover. The Achieving a Better Life Experience Act, passed by Congress in 2018, made it possible for 529 funds to be repurposed in the event the beneficiary (or a member of the beneficiary’s family) is disabled. Now, each year, a 529 owner may roll over up to the federal estate gift tax annual exclusion amount (currently $17,000) to an ABLE account. An ABLE account functions similarly to a 529 account for tax purposes but permits distributions to be made for the beneficiary’s disability expenses rather than just educational expenses. An added benefit of an ABLE account is that the first $100,000 isn’t considered a countable resource in most governmental benefit programs.

Student loans. The SECURE Act of 2019 made provisions to address the critical expense of student loans. The benefit is quite limited, however; 529 plan owners may now expend up to $10,000 (a lifetime limit) to pay for the qualified student loans of the 529 plan beneficiary or a beneficiary’s sibling.

529-to-Roth-IRA rollover. Although the most recent expansion of 529 rules technically doesn’t become available until next year, it represents a game-changing option for individuals with leftover funds in their 529 plans. This new option was made possible through SECURE 2.0, which was passed at the end of 2022. Starting in 2024, a 529 owner who has a 529 plan that has been open for at least 15 years may roll over up to $35,000 of 529 funds to the beneficiary’s Roth IRA.

It’s important to note the new rule’s limitations and the pending clarifications many individuals need to use this strategy. Although an owner may roll over up to $35,000, they may only do so incrementally in accordance with the Roth IRA annual contribution limit, which is currently $6,500.

In addition, the beneficiary must have earned income to support the contribution, and such funds subject to rollover (or the earnings thereon) may not have been contributed within the preceding five years. One typical Roth IRA rule that would not apply, however, is the income threshold for contribution. The owner could complete a 529-to-Roth-IRA rollover to a beneficiary regardless of their income level.

AWAITING FURTHER CLARIFICATION

There are important unknowns about the new rule, namely the effect of a change in beneficiary on the 15-year “clock.” Hopefully, clarification will come from the IRS or Congress before the effective date of the new option.

The key takeaway is that 529 plans, thanks to a variety of recent legislation, are more powerful than ever and have the expanded ability to be used for more than just college expenses.

David Haughton is team lead and an advanced planning consultant at Commonwealth Financial Network and provides estate, trust, charitable, education, business and Social Security planning support to Commonwealth’s affiliated advisors.