Are you unimpressed with your current 529 account? Maybe the fees are too high or the website is hard to navigate. Perhaps you’ve moved and want to consolidate your 529 plans to a single state.
Others may have recently learned that the son or daughter they've been saving for has decided to forgo college. If that's a situation you're facing, you may be thinking about transferring the funds to another child.
When you're considering 529 plan rollovers and transfers, you need to think through both the pros and cons before making any moves. In particular, taking tax implications (including clawbacks of previously taken deductions) into consideration is critical. These are some of the most important pros and cons of 529 plan rollovers and transfers.
529 Plan Rollovers Vs. Transfers
529 plan rollovers and transfers are two different strategies and have different benefits and drawbacks. Here's a quick definition of each:
- 529 Rollover: The process of moving your 529 funds to a different plan (in a different state).
- 529 Transfer: The process of changing the beneficiary within your existing 529 plan.
529 Plan Beneficiary Transfer
With a 529 plan, you're allowed to change the beneficiary at any time to one of your beneficiary's eligible relatives. Examples include siblings and step siblings, parents, cousins, aunts and uncles, and in-laws. Spouses of these family members are often considered eligible beneficiaries as well.
There are virtually no downsides to changing the beneficiary on your 529 plan. You can make a beneficiary change as often as you want without penalty.
But what if the new beneficiary already has his or her own 529 plan? In that case, you may want to consider a 529 plan rollover instead. Even if you're not looking to change beneficiaries, rollovers can make sense if you could switch to a plan with better options or lower fees.
While 529 beneficiary transfers have few drawbacks, 529 plan rollovers have important limits you'll want to be aware of in order to avoid tax consequences. Below, we cover the biggest pros and cons and 529 plan rollovers.
Pros Of 529 Rollovers
There are several reasons you may want to consider a 529 account rollover. Here are some of the benefits a 529 rollover may offer.
Better Investment Experience
Saving for college or graduate school is already challenging. But investing money for yourself or your loved one shouldn’t be a challenge. Unfortunately, many states have websites that make it tough to figure out how to invest in an automated fashion.
If you can find an easier account to use, you may be better able to set up an automated investment plan. For example, robo-advisor Wealthfront has a 529 plan (a state of Nevada plan) that makes it easy for contributors to save and invest on behalf of others.
Manage A Single Account
Parents who move across state lines may end up with two or more 529 plan accounts for each child. Managing a single 529 account is much easier and can make a lot of sense.
It may also make sense to combine accounts if a 529 account is inherited and the new custodian already has an existing 529 account for the beneficiary. This can make managing college savings easier.
Lower Account Fees
Unlike most retirement accounts, fees on 529 accounts can still be quite high. Some plans still have investment fees in excess of 1% per year.
Investors facing these high fees may want to rollover their accounts to a plan with lower fees or better investment options. Or if you're paying monthly service fees on multiple plans, combining them into one would also help to reduce your overall 529 plan costs.
Lock In Current Tuition Rates
As your kids get closer to college age, you may find that a prepaid college tuition plan makes more sense than investment 529 accounts. The more confident you are that a child will use prepaid tuition, the more of a value it presents.
Parents who feel confident that at least one of their children will use prepaid tuition credits may decide to roll their investments out of an investment plan and into a prepaid tuition plan. That way they can lock in today’s college prices even if their child won’t graduate for another seven or eight years.
Cons Of 529 Plan Rollovers
Rolling over a 529 account may make sense in certain situations, but it’s not always a good idea. These are some of the drawbacks of 529 rollovers.
May Owe “Recapture” Taxes
Recapture is when a state requires you to pay back previously taken tax deductions when you rollover a 529 plan to a new state. Some states will "clawback" deductions you received from their 529 plan if you switch to a different state's plan.
For this reason, rolling over a 529 account can result in a hefty (and unexpected) tax bill from a former state. Before rolling over a 529 account, check with a CPA to ensure that you aren’t in for an unpleasant bill next April.
Limited To One Rollover Every 12 Months
Each beneficiary can rollover a 529 plan once per year. But more rollovers can result in penalties. Most of the time, a once per year rule isn’t a big deal. However, it could be an issue if big life changes coincide.
Investments Unlikely To Change Much
Most 529 plans offer similar investment options. Typically, these plans focus on mutual funds that mimic overall market performance. It's unlikely that switching plans will yield a significantly better investment result.
May Lose Time In The Market
Rolling over an investment account takes time. Between selling the old assets and transferring them to the new account, your 529 account could be out of the market for several weeks.
While this doesn’t sound like a big deal, missing out on a few big market days can make a difference in your long-term performance. Rolling over a 529 account could lead to accidental market timing. The result could be good, bad, or neutral. Regardless, it's a risk you'll want to be aware of.
Special Rollover: Changing Ownership
There is another type of rollover if you're going to change account owners, but maintain the same beneficiary. This is what happens when, say, a grandfather owns the 529 plan and wants to roll it over to the father. In this case, the beneficiary (the child) is the same, but the account owner changes.
The IRS allows one tax-free account owner rollover per 12-month period for 529 plans with the same beneficiary.
However, while no income taxes would be due, you may need to file a gift tax return depending on your situation.
When To Consider A 529 Plan Rollover
Investments within 529 plans tend to be similar from state to state. Only details such as the investment experience, fees, and prepaid tuition options tend to vary among states. However, here are a few scenarios where rolling over your 529 account may make sense.
- You've always lived in a state with no state income tax.
- Your current (and any former states where you’ve lived) don’t offer tax deductions for 529 plan contributions.
- Your current or former state allows you to receive a state income tax deduction regardless of the 529 plan you use.
Be sure to check the rules carefully, because you don’t want to experience a state deduction “clawback” if you roll over to another state’s account. A CPA or a fiduciary financial advisor can help you determine which account makes the most sense for you.
If you do decide to rollover your old 529 plan to a new one, here are some of the best places to open a 529 plan today. Or if you're looking for a tool that makes it easy to automatically invest in new or existing 529 plans, you may want to consider CollegeBacker, where you can link your 529 plan account and start saving easier!
Continued Reading: How You Can Still Focus On College Savings In The Age Of Coronavirus
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.