What’s the value of a good education?

My “Pops,” pictured above, never attended a college or university. He required, however, one way or another, his 3 children did. He insisted on flying across the country to celebrate my graduation with my family. He’d be saddened by the current state of our scholastic and collegiate educational systems.

Educational costs are raging out of control. Student loan debt is at an all-time high. Public high schools are getting more and more dangerous. What’s a parent that values education to do?

More money can’t be the end-all answer. Everyone should get an equal shot at getting a good education, whatever form that may take. In the meantime, you need all the resources you can muster.

Tax-Free Investing for Education

If you’re considering spending money on education in the future, it would be a smart financial move to open and fund a 529 plan. Reservations I’ve harbored about 529s in the past have been eased through recently passed legislation. These changes have made it much easier to help a loved one with an educational gift fueled by tax-free earnings.

Whether you tell your little angel about the thousands of dollars you saved by using a 529 to fund their education is up to you. The named beneficiary of your 529 plan will love you for it regardless.

Most of you already appreciate the benefits of tax-free earnings and compounded interest: I’ve tried to hammer home the importance of Roth IRAs and Roth 401(k)-type plan options in your quest for financial independence. Of course, tax-free earnings are great for retirement and education.

A Quick 529 Refresher

Think of 529 plans as Roth IRAs for education. Like a Roth IRA, there is no federal tax deduction on contributions, but all future earnings (interest, dividends, and capital gains) accrue tax-free. The catch is that to make tax-free withdrawals, the money must be used to pay for the educational expenses of the named beneficiary of the plan.

For higher education (past the 12th grade), qualified expenses include not just educational expenses like tuition, books, and fees, but lodging and other living expenses too. There are no limits on the amount you can withdraw per year for higher education expenses.

The beneficiary is the person earmarked to receive the funds, whether it’s you, your spouse, kids, step-kids, or grandkids. As the owner of the 529, you can change the beneficiary once a year to anyone even remotely related to the original beneficiary.

Like other Roth investing vehicles, it’s best to try and contribute to these accounts early on. That maximizes your tax advantage and your tax-free earnings.

Biggest Fear

What if your child, grandchild, or other beneficiary forgoes college, or you save more than they need? Will you get stuck with a penalty and tax on the leftover money? These are the biggest fears prospective owners have had about 529s.

Fortunately, those fears have been eased thanks to legislation passed over the years, particularly one that took effect just this year.

529 Timeline

1997: The Taxpayer Relief Act establishes 529 plans. Initial provisions include tax-free earnings for higher education, a 10% penalty plus tax for non-qualified withdrawals, and the ability to change beneficiaries.

2015: Computers, laptops, printers, software, internet subscription services, and related technology used for school are added to the qualified distribution list.

2017: Qualified distributions are expanded to include Kindergarten through high school expenses with a $10,000 per year withdrawal limit.

2019: Tuition, supplies, and expenses for registered apprenticeships, trade schools, technical colleges, and other post-secondary education became eligible. The ability to use 529 money to repay student loans ($ 10,000-lifetime maximum) was also added.

2020: Expenses inclusive for special needs students, including therapy, special education materials, and other special needs student expenses become eligible.

2022: Added the ability of owners to execute a 529 to Roth IRA rollover, with restrictions, effective January 1, 2024.

529 to Roth IRA Rollover

I was more excited about this provision until I learned of the restrictions. Still, a 529 to Roth IRA rollover is another viable option to help you use any leftover 529 funds responsibly.

To be eligible for a 529 to Roth IRA rollover, contributions and associated earnings in the 529 plan must be at least 5 years old. Plus, the plan must have been open for at least 15 years. Rollovers are subject to a lifetime maximum of $35,000.

A beneficiary can’t just rollover $35,000 from a 529 to their Roth IRA and call it a day. There’s more to it than that:

• Beneficiaries must adhere to the yearly Roth IRA contribution limits (currently $7,000 or $8,000 if you’re 50 or older) when performing a 529 to Roth IRA rollover. That means it will take years to rollover larger amounts.

• The beneficiary must have earned income to qualify for a 529 to Roth IRA rollover. Just as when making a regular contribution, enough earned income is a requirement.

• 529 to Roth IRA rollovers count toward your yearly Roth IRA contribution limit. As an example, a 30-year-old beneficiary in 2024 can’t do a $7,000 rollover and make the maximum regular contribution ($14,000). They’d have to choose one or the other to stay under the $7,000 maximum contribution limit.

• Both the Roth IRA contribution limits and the $1,000 catch-up contribution are now indexed for inflation, but the new $35,000 rollover maximum isn’t, which seems rather short-sighted. Hopefully, the 529 plan rules, including indexing the $35,000 maximum for inflation, will evolve through legislation as they have in the past.

Attention Grandparents!

Grandma and Grandpa, you’re back in control! Money withdrawn from a non-spousal 529 no longer counts as income to the beneficiary on the FASFA. Plus, it won’t count as an asset on the FASFA either like with a parental 529. This rule change makes a 529 plan opened and funded by grandparents the ideal college savings strategy.

Before recent legislation, grandparents’ efforts to help a grandkid with a 529 plan would often backfire. Until this year, distributions from a non-parental 529 plan counted as income to the student on the beneficiary’s FASFA (Free Application for Federal Student Aid). That extra income often reduced the federal aid the beneficiary was due to receive. This prevented many grandparents from saving in a 529 plan for the benefit of a grandchild.

Well-healed grandparents may now even consider overfunding their 529 plan on purpose. That way, they can help with their grandkid’s education and eventually jumpstart their journey to financial independence too with yearly 529 to Roth IRA rollovers.

Finding a Custodian

Do you know the U2 song “Some Days Are Better than Others?” That’s certainly true. Some custodians are better than others too. The custodian is the entity that runs your 529. They pick the investments from which you choose and decide how much to charge for their services.

With 401(k)-type plans your employer is the custodian. Some employers do a fantastic job. Others, not so much. Some offer the equivalent of a dog plan. 529s are state-run, meaning one of our fifty states will instead be your custodian. Like days and employers, some states are better than others, so choose your 529 custodians carefully.

State Income Tax

If you live in a state that charges state income tax, start your 529 search with your home state’s 529 plan. Even though there’s no federal income tax break, most states that charge income tax offer a state income tax break on 529 contributions made to the home state’s 529. Assuming your home state doesn’t offer the equivalent of a dog plan, take the tax break and effortlessly boost your after-tax rate of return before you even start investing.

California is my state of residence. They’re one of the few states with a state income tax that doesn’t offer their residents a tax break. The ScholarShare 529  offers good investment options with low fees. I would have chosen it if they offered a state tax break. Instead, I looked elsewhere and found another plan with even lower fees. State-run 529s are open to all US residents regardless of state residency or where your beneficiary goes to school, so feel free to look around.

Resources

Nerdwallet, SavingForCollege, and The Motley Fool are good sources of information on 529 plans. So are the websites maintained by the state-run plans.

I recommend sticking with the direct-sold plans, meaning you won’t have to pay broker commissions. If you need help with management, choose a target-based index fund.

These are “set it and forget it” investments that require minimum effort on your part, much like the One Stop Shop Investment Plans I’ve recommended in the past for financial independence and retirement.

Recommendations

I’ve never been a big fan of the state of Ohio. In high school, I played in the annual Big 33 game (https://big33.org), which pits 33 players each from Pennsylvania and Ohio in a football game. (I played for Pennsylvania, and we didn’t win.) Moving on to Penn State, my teammates and I competed against the Ohio school with a name that now officially starts with “The”.

That’s why I was pleasantly surprised when I checked out Ohio’s 529 offerings. Not only do they offer a wide range of low-cost index funds, my preferred investment vehicles, but the fees the state of Ohio charges you are among the lowest around. It’s my new favorite.

California residents, childless female cat owners, investors of Haitian heritage, and even ex-Penn State football players are all welcome to invest in the Ohio College Advantage 529 plan. Beneficiaries can use it to attend any college or university anywhere in the country, even The® Ohio State University. Don’t break ‘ole Papa’s heart!

As an example of its affordability, the Ohio 529 plan offers a 2042-43 target index fund with an expense ratio of .0411%. The great state of Ohio tacks on another .125% for their trouble, making the overall cost to invest in a top-performing target-indexed fund a very reasonable .1661%.

If you’re a Utah resident, Utah’s Educational Savings Plan might be the best 529 plan in the country. Even if you’re not a Utah resident it’s worth checking out. I also favor the Vanguard® option in the Nevada College Savings Plan.

Asking for Help

If you’ve got kids, I suggest you forward this email to grandparents, former spouses, rich uncles, and anyone else who may be concerned about the future welfare of your child or grandchild. Education has gotten way too expensive. Multiple 529s are now hands down the best way to pay for it.

The following bears repeating: Non-parental 529 distributions no longer appear on the FASFA as income to the beneficiary and will not affect the beneficiary’s student aid package!