By Steve Dinnen
You just shuttled your youngest off to college, where a free ride — tuition, room and board — awaits her because she is so smart. But now you have a problem, because the money you tucked away in a college savings plan is no longer needed.
Until recently, taking that unspent money out of a tax-favored investment account and not spending it on education expenses triggered both income taxes and a federal 10% tax penalty. But the law has changed, so now you can divert unused dollars from these so-called 529 plans to a Roth IRA in the name of the beneficiary. No taxes, no penalties.
“This can be a real winner,” said Bob Petix, senior wealth strategist at Wells Fargo Wealth and Investment Management. “This is just a terrific expansion.”
Petix explained several conditions to successfully make the switch. For starters, the 529 plan has to have been in place for at least 15 years. Funds cannot be rolled into a Roth until five years after the funds were contributed or earned. Beneficiaries are allowed to roll over up to $35,000 over their lifetime into a Roth in their name. The limit is subject to an annual Roth contribution limit, currently $7,000, but you can make the switch over multiple years.
An added bonus is that the beneficiary, presumably in their 20s, gets a head start on a Roth, which is meant to generate retirement dollars decades in the future.
All 529 plans are run by individual states. Here, the 529 plan is called ISave 529 (formerly College Savings Iowa) and is administered by the state treasurer. The money is invested in mutual funds managed by the Vanguard Group. There is a small fee for this, just .17%, and the Investment Company Institute estimates that mutual funds in general charge a .44% management fee.
In addition to relatively low fees, returns for the 17 investment options in ISave 529 have been significant. The best performance has come from the domestic stock index portfolio, up a solid 26% during the past 12 months.
Iowa has increased the tax break on contributions to 529 plans to $5,500. Foster Group crunched some numbers and figured out that if each parent opens an account for their three children, they can get a $33,000 deduction on their state income taxes for their contributions. That’s a lot of money.
But so is putting three children through school. So study hard, kids. Win scholarships and ease that burden on Mom and Dad.
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