May 2024
Here are some key takeaways from their conversation:
- In California, 529 plan funds that are used for kindergarten through 12th grade private school tuition incur taxes and penalties.
- Up to $10,000 from a 529 plan can be used for student loan payments, but this is a lifetime limit.
- $35,000 of unused 529 funds can be rolled over (over several years because the annual contribution limit is $7,000 per year) into a Roth IRA for the beneficiary, with conditions:
o The 529 must be open for at least 15 years
o Contributions made in the last five years are not eligible for rollover
o Beneficiary must have earned income
- 529 funds can be used for tuition, mandatory fees, computers, books, supplies, and room and board, but specific rules apply. They can also cover food and groceries if the child lives off-campus, adhering to the university’s specifications.
- Parents can use 529 funds to pay rent for a home they own and rent to their child, but the rent must be comparable to on-campus housing prices, the income is taxable, and the child can no longer be declared dependent on their parents and must have their own health insurance.
- 529 funds can be used to pay for off-campus housing if the amount doesn't exceed what the school charges for on-campus housing.
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Hello everyone, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski joined by Wealth Advisor Patrice Bening. Patrice, thank you for joining us.
Good to be here, Chris.
Let's talk about 529 plans. I know that there are a number of different vehicles that people can leverage to save for their kids' future, whether it's for college specifically or for them later on down the road. But there's some confusion around 529s and what you can use the money for, and what qualifies as an education expense.
Well, it's funny, you probably want to have this conversation because, you know, I'm in the thick of this. But kind of to your point, I would say in the last 5 to 7 years, there's been a lot of talk about the uses of 529, especially when it comes to expenses beyond just college.
So a lot of folks have their kids go to private school. And so I have a 529 I've been saving for. Can I use the money? The answer is yes. And no. In certain states.
It's a very confusing one. Right. Because the headlines say you can now use up to $10,000 a year for kindergarten through 12th grade, but so the answer is yes and no.
But we are so lucky to be here in California. So, in certain states, you can do that successfully. In California, specifically using the 529 funds to pay for K-12 private school tuition is not considered a qualifying expense.
Right. So even though the headline says you can now do it- California is one of those states that does not allow it. And so if you were to take the money out and use it to pay for kindergarten through 12th grade, you would get hit with, what, a 2.5% California city tax.
So that's a special tax. And you also pay income tax on the earnings that you pulled from the 529.
Got it. So people really need to pay attention to the state rules in which they live to determine whether or not that's a qualified expense. Yeah. So let's talk about California specifically. What about being able to use up to $10,000 a year to pay for student loans?
So that is allowed. But that is a $10,000 lifetime, that you can ever apply towards a student loan payment.
And then last year there were some sort of new rules or thoughts around what you could do with excess money in a 529 plan. So let's say, all right, my kid's done with college. I've got money left over in this 529 plan. I don't necessarily have another kid or family member that I want to use the money for.
I can use up to $10,000 of it to help cover student loan payments. What else could I potentially use those excess dollars for?
This is actually something really wonderful. Part of the Secure Act 2.0 that allows up to $35,000 of leftover 529 funds to be rolled over into a Roth IRA for the beneficiary of that 529 so there's still right now, the IRS is unclear on if you let's say, if you have two kids, but only one 529, if you can split those beneficiaries. So right now you can technically because they have not defined that. There's also some nuances to this rule. So number one you must have had the 529 for 15 years. Two, if you have made contributions in the last five years, those contributions cannot be rolled over to the Roth IRA. And third, the beneficiary of the Roth IRA or who you're opening the Roth IRA for your child is now an adult. They have to have active income. And actually, I said up to $35,000, but it's not like we can take $35,000 and throw into a Roth IRA. We literally do it just like you would do Roth IRA contributions up to the annual limit for that particular year.
I'm glad you clarified that, because that's one of the misconceptions like, oh, I can move 35,000 into a Roth IRA. The answer is yes you can. You just have to do it in chunks over several years because the annual limit is $7,000 per year. And the beneficiary has to have a minimum of that kind of active income for you to roll over that amount.
Let's talk a little bit about what you can use 529 plan money for. Right. So obviously we know or we hear it can cover tuition, mandatory fees, computers, books, supplies, and room and board. What if I own a condo that my child is living in? Can I use the money to pay for room and board there?
So this is actually very interesting. And it came up in conversation most recently. So one of the clients that we work with currently lives in California. Their daughter's going to medical school out of state, and they are actually looking to buy a home in out of state, for her to be able to ... they both want to live there.
And then the daughter can also have a place to live. So now the question comes- a lot of parents want to have their kids, you know, get some skin in the game. So it's not going to be technically free, right? They're going to charge their daughter rent to live in their home.
You can absolutely charge your daughter's rent. But the question comes, can we use the 529 funds to pay for rent? This is technically room and board for their daughter. So the answer is yes. They can absolutely do that. A couple of caveats. The amount that they charge in rent and what they use the 529 for has to be that similar to what the school with charge if she lived on campus.
And you can find that out by going to the financial aid office or, or looking at the university online. Right?
That is correct. the other nuance is that the parents have to declare that income on their tax return, so they will have to pay taxes on that.
And that child can no longer be dependent on the parents. And this is a key thing.
Correct. So the child has to be off the payroll technically.
And I'm guessing I would assume that that includes they can't be on health insurance and other things too. Right. Completely separate in order to qualify, which is one common reason why most parents won't end up going that route. One other interesting thing I saw is that you can use the money to pay for off-campus room and board.
So that was that was nice to know. But you can also use the dollars to help cover some sort of food or grocery bills, even if they are living at home. Again, you need to figure out what you know, sort of daily maximum is for food, but dependent on the university, right?
Yeah, exactly. Yeah. And I think I'm learning that just because my son's going to go to college, a lot of schools offer meal plans. But if you choose, let's say to get their meal plan, you're going to pay out of pocket. You can still use your 529 to pay for the meal plan, AND your own food bill.
Interesting. And then one last point to clarify, in terms of being able to use 529 for room and board, most schools are nine months. Right. And so if you're, if your child is living in off-campus housing and they're signing a 12 month lease, you can only use the 529 for the nine months that school is in session.
Correct. So that's something that, you know, if your child is going to take summer courses, then you credit. But you have to be very careful on that because yes, typically you could only use for the amount of time that your child is going to school for.
Patrice, I love this topic because I enjoy 520 nines. I think they're a great way to save for your child's education in the future, but it's another reason to have diversification of where to access funds. We don't just need diversification in terms of how we invest, but the different buckets and where we can access money to help pay for things in life.
Your child might have things that come up that a 529 is not an eligible expense. So we should think about, in addition to having a 529 setting aside money and calling it a UTMA or UGMA account, another, you know, source of accessing funds where you don't have to worry about some of these rules and restrictions.
529 is not the holy grail for the college expense world. So yes, having a, an account that's just for the child, I would say the only caution with that is that those particular accounts weigh differently from a financial aid standpoint. So kind of looking at how I put college applications still at the assets and how they're weighted.
And that's all we've even had talks about how grandparents, that affects them, it is best to be the custodians of 529 because when that particular asset will never show on the application, not for the parents or the child. And now with the new FAFSA rules, the income is not counted either.
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