529 ACCOUNTS HAVE LONG BEEN A POPULAR WAY to set aside funds for education. They allow you to invest money for a beneficiary, and when the student is ready, the assets can be withdrawn free from federal (and potentially state and local) taxes — as long as you use them to pay for “qualified higher education expenses.”¹

“Tuition and required fees are the biggest college bills you’ll probably face, but there are other eligible expenses,” says Richard J. Polimeni, managing director and product management executive, Education Savings Programs, Bank of America. Those include:

• College costs beyond tuition: Certain room and board, books, supplies and equipment required for enrollment or attendance at an eligible educational institution
• Tech equipment and support: Computers and peripheral equipment, software, internet access and related services that are to be used primarily by the 529 beneficiary during any of the years the beneficiary is enrolled at an eligible postsecondary school
• Expenses for students with special needs: Certain other outlays necessary or required for the student to enroll at or to attend an eligible post-secondary school

What’s more, the list of what’s considered “qualified” includes these expenses as well:

• Certified apprenticeship programs: The cost of required fees, books, supplies and equipment for participation in a registered apprenticeship program
• Student loan payments: Interest or principal on qualified education loans up to a lifetime maximum of $10,000 for a designated beneficiary and each sibling of that beneficiary — the lifetime maximum is applied separately for the sibling’s and designated beneficiary’s loans
• K-12 education: Tuition at a qualified primary or secondary public, private or religious school. You’re limited to a federal tax-free distribution of $10,000 total per calendar year per designated beneficiary for all 529 accounts for that beneficiary.

While 529 accounts offer plenty of flexibility in paying education expenses, there are costs that cannot be covered with 529 assets. “Using 529 account funds, you could pay for tuition at an accredited institution for your child to get a music degree,” Polimeni says. “But if you use those funds to pay for private piano lessons, you’ll have to pay federal (and possibly state and local) income tax as well as a 10% additional federal tax on the earnings portion of the money you withdraw.” You will never pay income tax or the additional federal tax on the principal portion of your withdrawal, regardless of what it is used for.

What happens to unused 529 funds

The rules are flexible when it comes to how many students can benefit from a single 529 account. Suppose you set aside $200,000 in an account with your child as the beneficiary, and you spend only half of the money. You could change the beneficiary on the account to a member of the beneficiary’s family — including siblings, first cousins or even a niece or nephew — federal income tax-free.

If there’s still something left over, it can stay in the account indefinitely — and, decades later, you could change the account’s designated beneficiary and the remaining funds can be used to help pay the cost of a grandchild’s education. Or it could even be used to fund your own or your spouse’s continuing education. Consult a tax advisor about the tax implications.

There is also new legislation that gives 529s greater flexibility. Effective for distributions made on or after January 1, 2024, 529 assets can be rolled over to a Roth IRA without federal taxes or penalties if the withdrawal meets the following criteria:

• The 529 account has been open and maintained for at least 15 years.
• The Roth IRA is in the same name as the 529 account beneficiary.
• The rollover is paid in a direct trustee-to-trustee transfer to the Roth IRA.
• The rollover does not exceed (i) Roth IRA annual contribution limits or (ii) the amount of annual compensation (as defined in the Internal Revenue Code) of the Roth IRA owner. However, Roth IRA income limits do not apply to a rollover from a 529 plan account to a Roth IRA.
• The rollover is limited to the aggregate amount of contributions made to the 529 account (and any earnings) before the five-year period ending on the date of the rollover — and a lifetime rollover limit of $35,000 per 529 account beneficiary.

Consult your tax advisor to ensure your rollover of 529 assets to a Roth IRA meets all applicable requirements.

Beyond 529s: Another way to save for education

If you want to set aside money for educational activities that a 529 account doesn’t cover, you could consider a custodial account under the Uniform Gifts to Minors Act/Uniform Transfers to Minors Act (UGMA/UTMA). “However, there are potential drawbacks to that strategy,” Polimeni notes. Gifts to 529 accounts and to UGMA/UTMA accounts can’t be taken back, and you can’t transfer UGMA/UTMA assets between beneficiaries. What’s more, once the child you designate as the beneficiary of a UGMA/UTMA account reaches a certain age — which varies by state — he or she gains control of the account and can spend the money for purposes other than education. UGMA/UTMA assets are also treated less favorably in the federal financial aid process and therefore could have a greater negative impact on your beneficiary’s federal financial aid package.

Also, any gifts made to a UGMA/UTMA or a 529 account could count against your federal gift tax annual exclusion amount or use a portion of your lifetime federal estate and gift tax exemption depending on the amount of total gifts made by the donor to the beneficiary of such accounts, so you should coordinate your gifts appropriately. Your tax advisor and financial advisor can help you figure out what makes the most sense for your family.

Before you invest in a Section 529 plan, request the plan’s official statement from your Merrill Lynch Wealth Management Advisor and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the plan, which you should carefully consider before investing. You should also consider whether your home state or your designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds and protection from creditors that are available only for investments in such state’s 529 plan. Section 529 plans are not guaranteed by any state or federal agency.