Investing in 529 Accounts Just Got Even Better!

For doctors, investing in 529 accounts has always held some nice advantages. But, with the recent passing of the federal SECURE 2.0 Act, investing in 529 accounts got even better. Like a lot better.

So let’s dig in.

Because I know a lot of investors and doctors who continue to be hesitant to utilize these accounts to their full potential.

But let’s start with a review.

Investing in 529 accounts

A 529 account is an education savings account. You can contribute money tax free (i.e. pre-tax – assuming you live in a state that provides tax deductions for these contributions), invest it tax free, and withdraw it tax free so long as it goes towards your designated child’s education.

529 accounts don’t have contribution limits per se. But if you contribute more than $17,000 annually per child (in 2023) then you start to lose tax benefits as it is considered a gift by the IRS above that amount.

However, you also have the option of front loading a 529 account with up to 5 years of maximum contributions as a one time sum. So, in 2023, you could contribute $85,000 up front for each child (and not be able to contribute again for at least 5 years) rather than spread it out over 5 years.

What’s more?

Each state has its own 529 plan. And some are better than others. But you don’t necessarily need to invest in the 529 account of the state that you live in. You can invest anywhere.

However, most states will have some state tax deduction for contributions to their in-state 529 plan.

So, if you are considering contributing to a 529 (and more on why you should later), check out your state plan (you can find all state plans here). If it is better or similar to other states and your state offers a tax deduction, it probably makes sense to use your in-state 529. If your state has a really bad plan and no deduction, it’s an easy decision to use a better state’s plan. And lastly if your state has a deduction but a crappy 529 plan, weigh the benefit of the deduction against the lower fees and better investing options in another state’s plan.

So, let’s quickly lay out the main benefits of investing in 529 accounts before SECURE 2.0…

• Pre tax contributions in most states (which lower your taxable income)
• Tax free growth
• Tax free withdrawals if used towards child’s eduction
• Possible state tax deduction
• Freedom to choose among all state plans (however may lose in-state tax deduction)

All in all, that is pretty sweet!

That’s why Selenid and I contribute monthly to 529 accounts for all 3 of our children as called for in our written financial plan. And true, we do not maximize these accounts for our kids because we plan to pay for their college using a combination of these 5 methods.

But investing in their 529 accounts plays a big role in that plan.

But then the SECURE 2.0 Act was passed in December 2022

And things got even better!

But I will remind you that, while announced in 2022, these changes do not go into effect util January 2024. Which is why I am talking about this now. So you have some lead time to make any changes that you wish.

What changed for 529 accounts with SECURE 2.0

The SECURE 2.0 Act was a big one. With lots of changes. But one of the ones that tends to get glossed over a bit relates to 529 accounts.

Starting in 2024, qualified “leftover” 529 account funds may be transferred to a Roth IRA free of any tax, penalty or applicable income limits. Yeah! I know!

But what does this mean?

Well, one of the biggest concerns that people have with investing in 529 accounts is if they will have money leftover. Because, while you can re-assign excess funds to another child, any withdrawals not put towards a child’s education gets taxed and penalized 10%. Which is a big bummer.

So, people worry about their kids not going to college. Or not have enough education related expenses. Or getting a full ride. Maybe even getting financial aid (not super likely for high income physician families).

And, in these cases, what happens to the extra money in the 529. Wouldn’t it have just been better to invest it elsewhere? Somewhere it won’t fact both taxes and a big penalty? Even a taxable account is better in that sense.

Now, I’m not going to argue about the logic of that thought process. Because I think it is flawed. Education expenses are rising astronomically and look likely to continue doing so. And, if you are saving for your own retirement before contributing to your kids ‘s 529 account like you should be (remember, your kids can get a loan for school. But there are no loans for retirement), then this is rarely an issue.

But, either way, this new provision solves this problem!

Now, if you have up to $35,000 left over in a 529 account, you can just transfer it tax free to a Roth IRA (more on Roth IRAs here), where your kids can withdraw it tax free after age 65. That’s awesome!

Keep in mind though that the annual rollover limit is subject to Roth IRA annual contribution limits ($6,500 for 2023; $7,500 for individuals age 50 and older). And as mentioned above, there is a lifetime rollover limit of $35,000 for each 529 account beneficiary.

Should this change your financial plan?

Well, maybe.

Here are the 2 ways that these alterations may impact your investing in 529 accounts:

• If you have kids, it makes investing in a 529 account basically a no-brainer after you have sufficiently invested for yourself and are set to achieve your goal retirement next egg like you can calculate here. While beforehand, other options maybe seemed more attractive, 529 accounts with the ability to transfer excess to a Roth IRA in their name cover all of your bases: tax-deferred contributions, tax free growth, and tax free withdrawal potential. So, investing in 529 accounts likely moves up a step or so in your investment waterfall.

• If you don’t have kids (now or ever), investing in a 529 account can still make sense. You could invest in a 529 under your own name. And then, when you have a kid or kids, you can transfer it to their name(s). Or, if you never have kids, you can just transfer up to $35,000 to a Roth IRA in your name. (In this case, it makes sense to limit your contributions to $35,000 before you have kids in case.) That’s a new nifty version of a backdoor Roth IRA.

And there you have it

Investing in 529 accounts just got better. I have always argued that doctors should contribute to these accounts despite the minor potential drawbacks.

But now, there really is no excuse. These advantages are just too good to pass up!

And once you do this, check out these other helpful and fun investing posts!

• My 7 New Financial Plan Changes
• Debunking 7 Financial Myths Overheard in the Doctors’ Lounge
• Maximizing Tax Deductions as a Physician 

What do you think? Do you invest in a 529 account yet? Do these changes impact your plans to do so? Why or why not? Let me know in the comments below!