A Section 529 plan is a tax-favored way to save for a child’s higher education. Now the new law called SECURE 2.0 provides an option for using 529 account funds for retirement savings.

Background: Named after the tax code section authorizing its use, Section 529 plans are educational savings plans, generally operated by individual states, that encourage families to build up funds for the future education of the younger generation. If certain requirements are met, there is no tax due on the accumulation of earnings or qualified distributions.

There are two main types of Section 529 plans: Prepaid tuition plans and college savings plans.

  1. Prepaid tuition plans: Essentially, the plan is guaranteed to keep pace with the rising cost of college tuition. For instance, say that it currently costs $20,000 annually to send a child to a state university. You pay $20,000 now to buy shares plan for a youngster. When the child is ready to go to school, your shares can pay for an entire year of tuition, no matter what it costs at that point.

This type of plan offers some peace of mind. There is no risk of loss of principal and the investment is usually guaranteed by the state.

  1. College savings plans: In contrast, there is no guaranteed lock on future tuition costs under a college savings plan. In fact, the savings may not be enough to cover all of the costs. But you have a bigger potential upside as well, since it is possible to generate a better return with this type of plan. (Of course, there are no guarantees.)

Usually, the plan will feature an asset allocation strategy geared to the current age of the child or the year they will enter school. Most college savings plan also offer a wide variety of risk-based asset allocation portfolios managed by professionals.

Anyone can contribute to a Section 529 plan on behalf of a named beneficiary.

Each state is responsible for setting its own limits on the amount of contributions. Check the limits in the applicable state, but here is a link to Alabama’s 529 FAQs.

In the event a child decides to not attend college or attends school in another state, you may be able to transfer funds to another plan or “roll over” funds to an account for a successor beneficiary (e.g., a younger child). But amounts withdrawn for nonqualified expenses are fully taxable.

New rule: SECURE 2.0 Act provides another option. Beginning in 2024, a 529 plan account owner can roll over up to $35,000 in unused funds to a Roth IRA without paying any tax. To qualify for this tax break, the account must have been open for at least 15 years.

With a Roth IRA in existence at least five years, funds paid out after age 59½ are completely exempt from tax and penalties. So a 529 plan can now help fuel both higher education savings and retirement savings.

Ultimate question: Does a 529 plan or a rollover of unused funds to a Roth IRA make sense for your family? Investigate the possibilities or call your JMF advisor.