The new Secure Act 2.0 creates a new planning opportunity
Ric Edelman: It's Wednesday, February 22nd. A couple of weeks ago I talked with you about how college is becoming free. If you want to hear that bit, the link to it is in today's show notes. Dozens of colleges and universities, as I've told you, are making college free these days for low-income families. A lot of states are now doing that, too, and not just for low-income households, but for middle class families, too. And hundreds of companies are now paying for college for their employees. It's the newest employee benefit. So I said, you really need to rethink your college planning strategy if college is going to be free. Do you still need to save for college?
Well, guess what? Thanks to Congress (who loves to give freebies away to voters), yes, saving for college just might still make sense, even if you never have to pay for college, even if your kids never go to college.
Here's the deal. The best way to save for college is to open an account in a 529 college savings plan. I've endorsed this idea ever since Congress put this into the tax code way back in 1996. With a 529 plan, you put money into the account and it grows with no annual taxes. And if you use the money to pay for college, the withdrawals are completely tax-free. And in a lot of states, you get a state tax deduction on your contributions, too.
But there's a catch with 529s. If you don't use the money for college, then withdrawals are subject to taxes plus a 10% penalty. So if college is going to be free in the future, you sure don't want to put money into a 529 plan, do you? You'll just get hit with taxes and penalties if you do because you won't need the money for college.
No, not necessarily. That's because Congress has just created a new benefit for 529 plans. It's all part of a new law, the Secure 2.0 Act, which was passed by Congress last year. Starting in 2024, if you have money in a 529 plan that you don't need to spend on college, you can transfer the money to a Roth IRA account. And if you follow the Roth rules, the withdrawals will be tax-free when your child reaches retirement. In other words, you take money that you were saving tax-free for the child's college and it becomes money you're saving tax-free for the child's retirement. I'm so glad.
Let me give you the fine print. First, you can't make this transfer from the 529 to the Roth until next year. Second, you can only transfer the money to the Roth for the child. You don't get to move the money into a Roth for yourself. And you can only transfer $6,500 a year from the 529 to the Roth. And the total lifetime limit that you can move into the Roth is $35,000 per child, meaning you can only move $6,500 a year over the next five years or so. And you can't move money from the 529 unless the money has been in the account for at least 15 years.
Now, that's not as big a deal as it sounds. You open the 529 today, the money grows tax-free and after 15 years you simply transfer it to the Roth, where it will continue to grow tax-free until the child retires. And oh, by the way, not only do you have to wait until the account is 15 years old, but you also have to wait until each contribution or earnings on the contributions are five years old as well. So what if you've got more than $35,000 in the account?
Well, you can move money from one 529 account to another 529 account for another family member, somebody related to the student - their sibling, their spouse, their own child or grandchild, their in-laws (yeah, right), a first cousin, a niece and nephew, an aunt and uncle, even to you, their mom or dad. In other words, there's plenty of ways to distribute the money within the family so that everybody gets to enjoy tax-free growth.
So even though college is becoming free, retirement won't be. And now you can use college savings to help you save tax-free for retirement.
If you're a financial advisor, as I told you in my prior podcast, you need to rethink your college planning strategy. You need to revise the advice you're giving your clients. You need to make sure they are aware of this new rule in the new Secure 2.0 Act so that they're continuing to benefit under the tax code as best they can.
And if you're an investor, you need to realize that while college is fast becoming free, the need to save for retirement is as important as ever. And in a weird way, a college savings account can actually help you save for retirement for your children. You can learn more about going to college and making sure it doesn't ruin your life by watching my master class on college planning. You can watch it for free at TheTruthAYF.com and we'll put that link in our show notes as well.
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