2023 EP0129 | Financial Updates | Did 529s Just Become a Better Investment?

We want you to plan for success. Welcome to Planning Matters Radio. Hey Peter, it's good to see you.

I have an important question. Did 529s just become a better investment? Congress recently passed the SECURE Act.

We talked about that just a bit ago. And there are a lot of changes. But one of them is that if you have money left over from a college savings planner, a 529, you can now roll that money into a Roth account. So what was the original pitch for a 529?

Who should be considering them? Yeah, this is a big improvement and a big change. So originally, the 529 was a designated college education account with some significant tax benefits caveat, so long as the money was indeed used for college expenses and education. And they loosened the definition of what that meant a little bit several years ago to include like room and board and even rent as well as, of course, tuition. However, this has loosened the rules a tremendous amount and I believe improved the 529 utilization and ability because now with the passage of the SECURE Act 2.0, so long as the 529 has been open for at least 15 years, up to $35,000 of unused college education money can be rolled directly and tax free into a Roth IRA in the child's name. So a widening of the potential usage of the 529, some flexibility there that if the child doesn't end up needing the money for college education, that you can still use the money and not lose the tax benefits and I think actually improved the 529 significantly. Right. Yeah, I think you and I being young parents, it certainly does change the equation.

But what I want to know is does it radically change the equation if I were trying to figure out if I should open a 529? Well, I think that there are some things that we should put in as precursors and prerequisites there for anybody. Right. I mean, we all as parents want to do or grandparents, by the way, great things for our children or grandchildren. But we should always be prioritizing our own retirement preparedness. And I actually have this conversation pretty frequently and I give the analogy of flying in an airplane before you take off.

The flight attendant comes to the front, gets everyone's attention. And part of the safety speech is if there's problems and turbulence in the air and the masks drop from the ceiling, if you are traveling with children, make sure you secure your own mask first. And it's not because we don't care about the kids.

We absolutely do. But if we're not stabilizing ourself, putting ourselves in the best situation possible, then we don't really serve to stabilize those around us very well. And so I meet with parents and grandparents from time to time that want to help those children or grandchildren, but aren't doing the things that they need to do for their own retirement readiness. And in my mind, that's paying off all debts except for the mortgage, having your emergency account in place and saving at least 15 percent of your gross household income toward retirement. If you are doing those things and you have leftover discretionary funds, then we can talk about let's pre-plan, pre-save and help the kids prepare for those college expenses, which, by the way, now much more attractive in the form of a 529, because if the kids don't end up using that money, then it can be rolled over to a Roth IRA within those limitations, must be opened at least 15 years limit of thirty five thousand dollars. Now, an interesting kind of gray area there, as with several other items in the SECURE Act and a lot of things from government in general. But the 529 had an interesting ability to transfer among siblings and family members.

So the question in my mind is, if I have a 529 with seventy thousand dollars in it and two children, could I potentially transfer thirty five thousand dollars into the second child's name and now roll over to different 529 of thirty five thousand dollars? And I think that in the years to come, we'll probably see some clarification in that area. And then just to kind of state the obvious, one of the reasons that we encourage Roths or that people find them very attractive is we are in a historically low tax rate right now. So you could be setting your kids up for their retirement savings.

Absolutely. Yeah, Roths are fantastic vehicles and opportunities and really for the last generation since the inception of the 401K with ERISA in 1974, the paradigm has been defer and delay paying your taxes because you will be in a lower tax environment when you retire. And I think for the previous generation, this was a correct way of thinking. But I do think that the paradigm is shifting pretty dramatically. And what we are finding is even if we are in a lower tax environment, that our need for income is significantly higher than it was 20, 25, 30 years ago. And therefore, we are paying just as much in tax, if not more. Plus, a lot of people I talk to almost across the board per person believes the taxes could be going up into the future. And even more significantly than they are already slated to go up in 2026. So we've got some great kind of precognition of what the tax environment in the immediate future is going to look like. And could it go up even higher? Yes, it absolutely could. We're in, as you stated, Aaron, one of the historically lowest tax environments we've ever been in.

So could they go higher? Yeah, I believe so. And that makes these 529s and Roth accounts that much more advantageous. And I think it's important for people to know. Do you make money if a client opens a 529? There are ways that advisors could make money off of 529s.

I don't. And it's actually a service that I offer for free. If anybody would like to come in and needs help opening the 529 or linking it to be funded, I am more than happy to help with that because children are the future and I believe that giving them a head start in education is of great value. However, I am going to also try to make sure that anybody that I talk to that wants to do that is doing those prerequisites that I mentioned earlier and that they are in a position where saving a 529 is appropriate. But 529s don't take a tremendous amount of management. They're essentially target date funds. You choose the child's age.

You choose how aggressive you are comfortable being. And from there, it's pretty much on autopilot except for the contributions. And, you know, you can set up the contributions to where parents get automatic monthly deductions from their checking to go straight to the 529. Maybe if a grandparent gives a birthday gift, it can go right into the 529. Literally anyone can fund it with a code that you can generate. And that part's very simple as well. Right.

That's nice. So I think this all begs the question, though, why not just open a Roth account for my child or even fund their college through my Roth? Well, both of those are interesting opportunities, but they have limitations and not a lot of people realize the inherent flexibility of a Roth. When you've already paid your taxes on the seed and then placed that money into an account that grows tax free forever, the government doesn't mind as much if you want to remove some of those dollars and get them back into taxable circulation. But using money from your own Roth IRA, you can only pull out the original contributions that you've made without penalty or taxes. The growth on the contributions would have some restrictions on it. Penalties, 10 percent plus potentially taxes.

And so that's really money that you you don't want to put as as a first option. And then if a child has a Roth, which, by the way, fantastic additional opportunity for those children's retirement readiness, but they have to have earned income in order to get the Roth in the first place. And not a lot of children do have that earned income.

Or if they do, they're going out to the movies or buying gas or maybe paying for their car insurance or things like that. You know, kids younger than 18 seem to have other priorities than getting that money into a Roth IRA. But bottom line is not a lot of kids have Roth IRAs.

And if you were to consider repurposing Roth money for college expenses, not only does it take money out of your retirement readiness, but you are limited to only the original contributions without potential penalties. Interesting. I really enjoy having this conversation again, especially as a young parent.

I think that it's very topical right now. But Peter, if somebody has questions about anything we've covered or like you mentioned, if they would like some help setting up a 529, what's the best way to reach you? Yeah, you can give me a call. 529 Roth IRA. If you need help setting up any of those kind of retirement or investment or college education accounts, give us a call at Rashaan Planning, 919-300-5886, 919-300-5886. You can email me Peter at Rashaan Planning dot com. That looks like Rich on Planning dot com.

Peter at Rashaan Planning dot com. By the way, the SECURE Act are not the only legislative change to funding college. There were actually changes with the FAFSA laws as well, which opened up some opportunities for grandparents 529 not to count against the child recipient when applying for student aid. So a couple new kind of twists in promoting college expense, readiness and preparedness and I think improvements all the way around. Right.

Yeah, I think they called it the grandparent trap now. Absolutely. That's better. All right, Peter, thank you very much.

All right. Thanks, Erin. This has been Planning Matters Radio. The content of this radio show is provided for informational purposes only and is not a solicitation or recommendation of any investment strategy. You are encouraged to seek investment tax or legal advice from an independent professional advisor. Any investments and or investment strategies mentioned involve risk, including the possible loss of principal advisory services offered through Brooke's own capital management. A registered investment adviser fiduciary duty extends solely to investment advisory advice and does not extend to other activities such as insurance or broker dealer services. Advisory clients are charged a quarterly fee for assets under management while insurance products pay a commission, which may result in a conflict of interest regarding compensation.