With the start of the new year, a number of notable changes are occurring in the realm of financial planning rules. Most of the rule changes are the result of the Secure Act 2.0 phasing in, but some are the result of the higher inflation experienced over the past few years. With some awareness and preparation, a window of opportunity has opened for some planning improvement using the new regulations. Let’s go over a few.
One significant change involves 529 education savings accounts. As we’ve discussed in the column before, the potential tax benefits of a 529 savings account are threefold in Indiana. These special education savings accounts enable tax deferred accumulation of investment returns, and when used for education expenses, these accounts also enable tax free withdrawal of investment gains. Also, in the state of Indiana when using the Indiana plan, amounts contributed to the account are eligible for a 20% tax credit up to a maximum credit of $1,500 on a $7,500 annual contribution. With these attractive tax benefits, many families we work with have used these plans to effectively plan for education expenses.
This being said, a very common question I hear when discussing college planning, utilizing 529 savings plans, is “what if my child/grandchild doesn’t go to college?” The question is valid, as often times the conversations regarding these plans are occurring when the child is under the age of 5 and it’s impossible to know what choices he or she will make in the future. Until now, the answer wasn’t great.
If the funds in the account were not used for education of some sort, either private school tuition or college costs, the gains in the account, not the principal, were subject to income taxes as well as a 10% tax penalty when withdrawn. While another option could be to change the beneficiary on the account to another family member, once again these conversations were often occurring with families with young children, and this feature did not always bring more clarity to the question.
Starting in 2024 however, the answer to the question becomes more attractive. Value held in 529 savings accounts not used for education costs can now be transferred to the child’s (who will then be an adult) Roth IRA, helping them jump-start their retirement savings. While this new rule is much improved in my opinion, it does come with a of couple strings attached. The 529 plan must have been open for at least 15 years before rolling over into a Roth IRA, and funds contributed during the last five years are not eligible for conversion. Also, money rolled over is subject to yearly Roth IRA contribution limits, which in 2024 is $7,000 per year, and there is a lifetime transfer cap of $35,000. Even with these stipulations, however, I feel the new rules provide a nice option to consider when families are ready to start saving for a child’s future.
Other notable changes are occurring with income tax brackets in 2024, which are indexed to inflation. Tax brackets across the spectrum are rising, which means more income at all levels will be subject to lower tax rates. The IRS is also changing withholding tables for employers, which means larger net paychecks almost immediately this year. In addition, the standard deduction is also indexed to inflation and will be increased to $29,200 for married taxpayers, and $14,600 for single taxpayers. Using some quick and simple math, I estimate a couple with $100,000 of gross income will see roughly $2,000 in increased after-tax income in 2024 due to these changes.
A number of other rule changes involve retirement savings accounts such as IRAs, 401(k)s and 403(b)s, all of which are seeing increased contribution limits, as well as some adjustments to rules on early withdrawals, which we will explore in future columns. One quick planning suggestion is, before the increase in the net paycheck gets integrated into the family’s spending, why not contact payroll and drive at least some of the projected increase into the ole 401(k) or 403(b)? The window is open now, if you act quickly, and when it comes to retirement savings, every little bit helps.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor.
Prior to investing in a 529 Plan investors should consider whether the investor's or 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 only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.