2024 Brings New Rules for Education and Retirement Investment Plans

By Dan Ahl, Associate Portfolio Manager

A new year means new rules for 529s, Roth IRAs, & employer-sponsored retirement plans. Every year we see updates to the rules and regulations on a variety of different investment accounts and we want to highlight some of the changes for 2024. We will start with Qualified Tuition Plans, otherwise known as “529s” or college savings plans, which saw several updates. These investment accounts are sponsored by states, state agencies, or educational institutions and are intended to help families save and grow their money to pay for qualified educational expenses.

First, as is typical most years, the annual tax deduction was increased in the state of Iowa for 2024. The deduction is now $4,028 per beneficiary, up from $3,785 in 2023. It’s important to note that in Iowa each parent may hold a separate 529 account for each beneficiary which increases the annual combined tax savings to $8,056 per year per beneficiary in a two-parent household. The state of Illinois remained unchanged, allowing for a $10,000 state deduction for single filers and $20,000 for joint.

Keeping it in the family, the grandparents of 529 beneficiaries are receiving some good news as well. Past FAFSA rules dictated that distributions from 529 accounts owned by a grandparent would be reported as untaxed income to the beneficiary. This could sometimes cost the student a whopping 50% in student aid eligibility. Beginning in 2024, however, any distributions from a 529 account owned by a grandparent will not be included in the FAFSA calculation. A student’s total income will only be derived from their individual federal income tax return, greatly reducing the risk to their student aid eligibility.

529 accounts saw some additional changes this year as well. For many years the “Achilles heel” of a 529 account was the issue of what to do with unused educational savings upon completion of their educational program. Perhaps the 529 owner saved “too much,” or worse yet, what if the beneficiary never ended up in the type of educational setting that qualified for the use of the funds? Prior to the most recent update both scenarios would require the participant (owner) to withdraw the funds as a non-qualified withdrawal and incur a 10% IRS penalty (no, thanks!).

Beginning this year, though, owners are permitted to roll over the funds into a Roth IRA for the beneficiary of the 529 account. However, this newly added, and much appreciated, flexibility does come with some limitations. First, the account must have been maintained for at least 15 years. Additionally, rollover contributions cannot exceed IRA contribution limits (currently $7000 for ages 49 and under) and is reduced by any other Traditional or Roth IRA contributions made by the beneficiary that year.

Perhaps one of the biggest hoops for this update is the one that has gained the least amount of attention. While rolling over 529 funds into a Roth IRA will negate any federal tax consequences, most states have yet to adopt this rule. Both Iowa and Illinois will still consider this transaction a non-qualified withdrawal as it is not being used for educational purposes. This subjects the transaction to “recapture” in most situations – meaning that any contributions to the plan that were deducted from previous years’ state taxes must now be included as income. It remains to be seen if, how, and when each state chooses to further address this. Will they join the federal government and adopt rules to make this a tax-friendly transaction? Perhaps. Or perhaps we will be stuck with the tax bill from the states. If you are considering this option, it is best to seek out a conversation with your tax advisor to understand how it will impact your own situation.

Lastly, keeping in stride with our college-related theme, is a lesser-discussed update from the Secure 2.0 Act. Beginning in 2024, employers now have the option to provide a “match” to employees’ 401(k)s if they are paying down student loans. Now, as with most new government-related programs, this one currently produces more questions than answers.

It will be interesting to see which employers, if any, decide to take this up. If they do, there will still be many hurdles such as: does the employer have an eligible retirement account (401(k), 403(b), 457(b), or Simple Plan), is the loan being repaid a qualified educational loan, do private student loans qualify, and how will the employee certify to the employer that they are indeed making the student loan payments? As a first of its kind benefit option employers have no prior example of how to implement this without creating a costly and time-consuming burden. If it were to be adopted by employers, it could be a game changer for many and a potential win-win. Employers could apply additional tax write offs to their bottom line while employees who can’t afford to save to their 401k, or even those who can only afford to save the minimum due to high student loan repayments, could begin saving to their retirement plans earlier.

All in all, we are excited about the changes to these programs in 2024. While we wish we had a bit more clarity on some of the potential downsides and unanswered questions, the important thing is that the changes are here and it is possible to benefit from them now. It remains to be seen if the states will follow the federal government’s footsteps and make 529 rollovers to Roth IRAs tax-free.

Also, will employers take up the option for employer student loan matches to 401(k) accounts even though the overall structure is not yet fully standardized? As the year unfolds, we will be watching and keeping you updated. Until then please feel free to reach out with any questions.