When it comes to securing the best possible future for our children, few things are as important as their education. A well-structured 529 Education Savings Plan is one of the most effective ways to ensure your child can pursue higher education without the crushing burden of student loan debt. However, the 529 Education Savings Plan updates have introduced some significant changes that every parent, grandparent, and guardian should be aware of – especially concerning FAFSA adjustments and the new ability to roll over 529 funds into a Roth IRA.

If you’re serious about strategic financial planning for your family’s future, these updates are not just interesting; they’re game-changers. Some advice from an independent financial advisor might help you maximize these benefits while avoiding common pitfalls, so let’s break down what these changes could mean for you and your family.

The 529 Education Savings Plan: A Refresher

A 529 Education Savings Plan is a tax-advantaged investment vehicle designed specifically for educational expenses. Contributions grow tax-free, and withdrawals for qualified educational expenses (such as tuition, books, and room and board) are also tax-free at the federal level. Many states offer additional tax incentives for contributing to a 529 plan.

Historically, 529 Education Savings Plans have been used almost exclusively for higher education expenses, though they have expanded in recent years to include K-12 tuition and even student loan repayment. However, new legislative changes have added even more flexibility to these plans.

FAFSA Loophole: A Win for Grandparents

For years, one of the drawbacks of 529 Education Savings Plans owned by grandparents was their impact on financial aid eligibility. Under previous FAFSA (Free Application for Federal Student Aid) rules, distributions from a grandparent-owned 529 plan counted as untaxed income for the student, which could significantly reduce their financial aid eligibility for the following academic year.

The good news? The FAFSA simplification changes, which take full effect for the 2024-2025 school year, have eliminated this issue. Now, assets in a grandparent-owned 529 plan are no longer required to be reported on the FAFSA, and distributions will not count as income for the student. This effectively creates a FAFSA “loophole” that allows grandparents to contribute to their grandchildren’s education without negatively affecting financial aid eligibility.

What This Means for Families

For families who want to maximize financial aid eligibility while still leveraging a 529 Education Savings Plan, this is a significant advantage. Parents can use their own 529 plans for the first couple of years of college, while grandparents cover later years using their own 529 funds. Because FAFSA now only considers parental and student income and assets – without factoring in grandparent-owned 529 distributions – students may qualify for more financial aid.

If you’re planning to use this strategy, consulting with an independent financial advisor is highly recommended. They can help you structure your contributions to take full advantage of financial aid opportunities without compromising your long-term savings goals.

Roth IRA Rollovers: Greater Flexibility for 529 Education Savings Plan Funds

One of the biggest concerns parents have when contributing to a 529 plan is the “what if” scenario. What if my child doesn’t go to college? What if they receive a full-ride scholarship? Previously, unused 529 funds could be transferred to another family member’s education expenses or withdrawn with a penalty for non-qualified expenses. Now, a new option provides even more flexibility.

The New Roth IRA Rollover Option

As of 2024, the SECURE 2.0 Act allows for a tax-free rollover of unused 529 funds into a Roth IRA for the beneficiary, subject to certain conditions:

• The 529 account must have been open for at least 15 years.
• Rollovers are subject to annual Roth IRA contribution limits.
• A lifetime rollover limit of $35,000 applies per beneficiary.

This new rule offers a fantastic opportunity to transition education savings into retirement savings without tax penalties. It ensures that even if a child doesn’t use all of their 529 funds for education, the money can still be put to good use in a retirement account.

Why This Is a Big Deal

For many families, the hesitation to overfund a 529 plan stemmed from uncertainty – no one wants to put too much money into an account that could incur penalties if left unused. With the Roth IRA rollover option, this concern is alleviated. Even if a child doesn’t pursue a traditional college path, the funds can still contribute to their long-term financial security.

Making the Most of These 529 Education Savings Plan Updates

These updates make the 529 Education Savings Plan more versatile than ever, but maximizing its benefits requires careful planning. Here’s how you can make the most of these changes:

1. Leverage Grandparent Contributions Wisely

If you have family members who want to contribute to a 529 plan, consider having grandparents open and fund their own accounts. With the FAFSA rule changes, this strategy can help maintain financial aid eligibility while still covering education costs effectively.

2. Plan for Long-Term Flexibility

Since 529 funds can now be rolled over into a Roth IRA, overfunding a 529 plan is less of a risk. If you’re concerned about “locking up” too much money, remember that any excess can contribute to retirement savings.

3. Work With an Independent Financial Advisor

The nuances of these changes mean that having an experienced professional on your side can make a huge difference. An independent financial advisor can help tailor a savings strategy that aligns with your family’s goals while navigating the complexities of financial aid and tax benefits.

4. Start Early

The sooner you start a 529 plan, the more you can take advantage of tax-free growth. Even small contributions early on can make a substantial difference when compounded over time.

The Future of Education and Financial Planning

Investing in education is one of the most meaningful ways to secure your family’s future. The 529 Education Savings Plan updates make it more flexible and beneficial than ever before, whether you’re a parent saving for college, a grandparent contributing to a grandchild’s education, or simply looking for a strategic financial planning tool with long-term benefits. 

By taking advantage of these new opportunities, you’re not just saving for college – you’re investing in the lifelong success of your loved ones. And that’s a future worth planning for.

Morris Financial Concepts is an independent investment advisor registered under the Investment Advisors Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Morris Financial Concepts, including our investment strategies, fees, and objectives, can be found in our ADV Part 2, which is available upon request.