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529 Masterclass: Three strategies to maximize the benefits of education savings plans
Episode 11826th September 2023 • Financial Life Planning for Busy Parents • Mike Morton, CFP®, RLP®, ChFC®
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Three Advanced Strategies for the 529 Education Account

Want to supercharge your savings? Look no further than 529 Education Savings Plans! If you're intrigued by the idea of making the most of your 529 accounts, I have just the podcast for you. This week Matt Robison and I discuss three advanced strategies that can help you get the most out of these versatile financial tools.  

Use a 529 to fund education expenses for a future (unborn) child

  1. No Kid, No Problem - Have you ever considered opening a 529 account for a child who hasn't arrived yet? It might sound unconventional, but it's a smart move for forward-thinking parents and grandparents. By starting a 529 for an unborn child, you can get your money growing tax-free today. You become both the owner and beneficiary of the account initially, allowing you to make contributions early on when you have fewer financial responsibilities. This can be a game-changer down the road in two ways:
    1. Pass it On: When your child is born or a grandchild comes along, you can simply change the beneficiary of the 529 account to the new addition. The compounding works in their favor to fund their education
    2. Fund Your Roth IRA: Fast forward 15 years when you might have more expenses and a higher income. The money in the 529 account can serve as a source to "contribute" to your Roth IRA. This is a creative way to maximize your retirement savings within the annual Roth IRA contribution limit while enjoying the tax benefits.
 

Dynasty Trust: Use a 529 for future generations

  1. Dynasty (The Trust, not the Soap Opera) - A Dynasty Trust can be an excellent option for families with substantial wealth looking to create a lasting financial legacy. While it's a powerful strategy, it comes with some complexities, including potential gift tax and Generation-Skipping Transfer Tax (GSTT) implications, maximum contribution limits, and state-specific rules. For an in-depth look at this financial tool, check out this Kitces Article.
    1. Long-Term Wealth Preservation: Dynasty Trusts are designed to ensure that wealth remains within a family for multiple generations. You can establish a 529 account within a Dynasty Trust to fund educational expenses for your descendants.
    2. Tax Implications: It's crucial to work closely with a financial advisor or estate planning expert to navigate the potential tax implications of a Dynasty Trust. This strategy is best suited for high-net-worth individuals.
    3. Not without Risk: Keep in mind that while Dynasty Trusts offer incredible benefits, they come with some risks. Future changes in 529 plan transfer rules, shifts in government policies, or unforeseen events may impact the effectiveness of this strategy.
 

How to use a 529 to fund your Roth IRA

  1. The Escape Hatch: As mentioned above, 529 accounts can now serve as a source of funds to contribute to your Roth IRA. This strategy is particularly beneficial when you're younger, have fewer expenses, and can generate "extra" savings. Here's how it works:
    1. Me, Myself and I: Open a 529 account in your name, with yourself as both the owner and beneficiary. Fill it up with your extra cash while you have it (i.e. before kids).
    2. No money, no problem: Down the road, when you have more financial responsibilities (mortgage, cars, children [and the separate 529 accounts to go along with them], aging parents, etc.), you can use the funds in your529 account to "contribute" to your Roth IRA. This allows you to maximize your retirement savings while staying within the annual Roth IRA contribution limit.
    3. No Income Limits: Unlike traditional Roth IRA contributions, this strategy has no income limits, making it accessible to a wider range of individuals. Check out this article from the AARP on Traditional and Roth IRA contribution limits.
  529 accounts have evolved into powerful financial tools that extend beyond education savings. By exploring these advanced strategies, you can make the most of your 529 accounts, secure your family's financial future, and even boost your retirement savings. However, it's essential to consult with a financial advisor or tax expert to ensure these strategies align with your specific financial goals and circumstances. With careful planning, you can unlock the full potential of your 529 accounts and achieve your long-term financial objectives.

Transcripts

Matt:

Wait, I don't even have to have a kid to start a fight.

Mike:

What's up with that? Yeah, it's true. You don't have to.

Matt:

Hey, this is financial life planning, I’m Matt Robison, and I am joined by my co-host, as always, Mike Morton of Morton financial advice. Wait. So first of all, that was exciting for our listeners, that was Mike's first experience with a cold open, a cold open is where you just kind of start in the middle of the action and it's like a little clip. It's like a little preview of what's about to happen, we were just doing a show about Roth’s and 529’s and this new wrinkle in the tax law. And Mike, it seems to have gotten you inspired that there's like, lots more beneath the 529 account. And I think it's a good idea. You want to do some bonus 529 strategies.

Mike:

Yeah, I figured we’d throw in some advanced strategies. First of all, I like the cold open that caught me by surprise. I don't even know what that means.

Matt:

That's why I didn't explain to you what it was beforehand, because it's supposed to be cold. I wanted it to be super organic.

Mike:

It was very organic and cold.

Matt:

No one expects the cold open.

Mike:

No one, no one, no one was ready for that, Matt. Yeah, so we were talking about 529’s and of course, the new rules in the Roth IRAs mix, and you know, the, you could transfer some leftover money if you happen to have it into the Roth IRA, which is great. And so it got me thinking about a couple of other advanced strategies that we can use for 529s. So I thought we'd bring that to the listeners today. We've got three tips, I'm sure there are more out there, but I've got three to bring your way that might make sense again, might make sense for you. So good things to know about.

Matt:

Alright, programming note, we just did this episode about this cool new wrinkle about this kind of interesting Venn diagram overlap between 529s and Roth IRAs. We'll get into that a little bit in this show but you can go back in the feed either in financial life planning, or we're also in my podcast, beyond politics, you can check that out over there and get kind of the full deep dive. And also programming note, we've done shows on 529s before, and we've done some really interesting pieces, we've broken it down. There's all kinds of considerations about what state plan you go with, and whether you run your current educational expenses even if you're not in college, or don't have kids in college with 529s. Check those out, alright, but this is all bonus, right?

Mike:

There's extra stuff, and one of the reasons to bring this up, Matt, is I often run into clients that are great savers. And so they've saved a lot, they're maxing out their employer retirement account that 401k or 403b, they're doing some IRAs, if they can put money in there, but they still have leftover savings, and they're saving it just under the regular checking, saving brokerage account. And they've built up quite a bit of money there. And so they remember that brokerage accounts are taxable accounts. And so you have this tax drag every year, you don't get the full return even if you've got a you know, S&P 500 Index Fund, all the dividends that are coming off of there get taxed every year. So we call that a tax drag and so it'd be great if there's other accounts that you could shove some money into that don't have that tax drag. And that money that's in a 529 grows tax free. And potentially you get it out tax free for all the things that we've mentioned about and talked about before. So that's a setup here is if you find yourself in that great saving category, maybe you're young and you've got extra money you're saving, maybe you've built up a bunch of savings, here's potential ideas that try to get that money growing tax free for you, rather than just sitting in your taxable brokerage account.

Matt:

Well first one here, and I have to admit, I haven't looked super deeply into all of these bonus things so I'm on a voyage of discovery too, much like you and the cold open mechanism. Let's go back to the cold open. I love this idea. You kind of introduced this in the last show we did about that overlap of Roth's and 529s, this idea of like, you know what, first of all, you don't have to have a child right now. And also, there could be future children. I'm not trying to step on what we're about to talk about, but we run this ground for me, because I think this is news to a lot of people if you're thinking about what to do with your savings and how to get it growing tax free. But you might dismiss the idea of a 529 with oh, that's for education expenses, that doesn't apply to me. Nope!

Mike:

That's right. Yeah, 529s. I recall that a 529 as an account owner. So typically, you open it as the parent, maybe open the 529, and it has a beneficiary. And typically, as you mentioned that that would be your child that you expect to have college expenses in the future, but the beneficiary can be wait for it, it can be yourself, you can open up a 529 as the account owner, and you are the beneficiary. So let's put you know, let's let's see how we can apply this. If you're the beneficiary it could be for future education expenses for yourself. That's great. You want to go back to school, you want to get some different degrees, you can use it for all kinds of things. So that's a potential option. But the other one is if you're thinking about having a family so you're young we're thinking, hey, we might have some kids in a couple of years, you could open a 529 now, with yourself as the beneficiary, the account owner and beneficiary put money in there, have it start growing tax free. And if you do have kids in a couple of years, you can always change the beneficiary to the kids. So it gives you you know, maybe a couple of years head start on growing that money tax free.

Matt:

Oh my gosh, your kid is the player to be named later in the trade, right? It's like have you ever seen one of these NBA or NFL trades. It's we just traded Mike Morton for a player to be named later and there'll…

Mike:

Be a drought, it'll be a draft pick.

Matt:

Your future draft pick is your kid. First of all, why is it for cash considerations? Why add the word consideration that is duplicative for cash? We just kind of do it for cash trade. Okay, Mike, by the way, this is a great time for me to tell you we traded you for it's not for considerations, it's I just, I just need the money. This is spectacular. I love the idea of a 529 for an unborn child, start and yourself can be a placeholder that can become real, or it could be a future kid. And I am already going to step on this. I'm going to spoil it. It could be a grandkid. Like, you know, you could change the player to be named later, multiple times. This is amazing to me.

Mike:

And the other, the other great reason I love this strategy is because often when you're first starting out in your career in your 20s, maybe you're not making that much money, hopefully you're saving, you're maxing out what you can always say try to save at least 15% of your gross income. But in your late 20s, early 30s, maybe straight before you're thinking about having that family, that's a time in your life where you might have a little bit of extra savings, you've been in your career for 5 or 10 years, you've gotten a little older, you've got you know, moved up the path, you're making more income, right, gotten a few raises, but you don't have the expensive kids, Matt, you and I know. Let's not tune in all the listeners how expensive kids can be, but you don't have that quite yet. So you've got this extra savings. And so here's a way that you can, hey, we're going to start having a family, we're starting to think about that boom, you can use some of the extra savings, get it growing tax free. So that's the other reason that I love this strategy, especially for that time of life.

Matt:

Right? Well, it does remind me of the old saying beer, it's not just for breakfast anymore, and 529s don't be fooled. You don't have to have kids. Now, the the major discussion we had in that recent episode was people get a little nervous. I think before now, justifiably so about what if I put money into an education expense tax free account, that's what a 529 is. And I don't have education expenses and what you're saying is not only do we have this great feature of like, name your player later, name your kid later, name your grandkid later but also, there's now an escape hatch here.

Mike:

Right. And that strategy number two plays into strategy number one as well. So the first one is this is what happens, Mike I put some money in but then we couldn't have kids or we changed our mind or whatever it is. First, as we've talked about many times, you can use it for a variety of different family members, nieces, nephews, cousins, yourself, etc. So you could do that. And now we have the escape hatch, too, which is you can if you leave it in there for 15 years, you can roll it into your Roth.

Matt:

Right. And that's, I think, super important for people to avoid this idea that it's not just for breakfast anymore. And anything else you just if people don't want to give a look, I want people to go back and listen to that whole other episode. But any other features that you want to highlight in terms of, you know, just knowing the lay of the land with this new rule?

Mike:

Well, we'll get into it now, because I'm gonna talk about strategy number two, which is this idea of using the 529 in the meantime, with the idea that you're going to put it into your Roth IRA. Alright, so this is not like for a future kid, this is literally Hey, I'm going to use this advanced strategy, I'm going to get some money growing tax free, in my 529 now with the intent to roll it in the Roth IRA later.

Matt:

Oh, my gosh, this is the Neo-approach, it's like there is no spoon. You're saying there is no kid like to have one, you open the five to nine anyway, because you've got this escape hatch.

Mike:

Yes. Now, I should have mentioned right at the top of the episode, but since we had the cold open, it totally slipped my mind, these are advanced strategies, things can go wrong with these. Alright, we're trying to make assumptions for the future, what if I don't have kids? And this one, it's what if Congress changes the rules again? What if all kinds of things could happen and go wrong with this? What if the IRS comes down? And like no, you can't these are supposed to be for education. And you can't just roll it like this with never having a kid or something. So again, these are advanced strategies, would I recommend them to clients? Yeah, in certain situations, absolutely. I would talk about it, but it's really up to you to understand the risks of each strategy, and whether you know, this makes sense for you. Are you ready to create your ideal lifestyle? Let's discover what's most important to you and design a plan to have more of that in your life. You go to meet Mike morton.com. All one word meet Mike morton.com.

Matt:

Hey, can we sidetrack for a quick second this is where my experience as a congressional staffer might play in. In general, what I found is that when Congress changes tax laws, they tend to put in safe harbor provisions, meaning if you are operating under a set of rules in good faith at the time, and then Congress changes the rules, there's usually a ramp down period. And there's usually a safe harbor, which says, if you get to continue to play out, whatever you set up under those rules, and the change is going to be forward looking for new people. So my point is, in general, I would think that if you adopt this advanced strategy, where you are opening up this 529 account with the intent of simply eventually passing it through to a Roth IRA, even if Congress changes the rules, you'd probably still be safe. But of course, that's no guarantee, that's my experience.

Mike:

Yes, that's my expectation as well. The only caveat is the first one. Yeah, I was planning to have kids, it didn't happen so I had to use one of these other things. This second one, if you go in saying, Hey, I'm going to use this to avoid taxes, which is essentially what we're trying to do, and never having a kid never wanting to do it, then they could come down and say, No, you're not allowed to do that. I'll give you an example, we use backdoor Roths all the time, you put the money into the traditional Roth, because you make too much to contribute directly to the Roth IRA, you put money into the traditional IRA a few weeks later, you change your mind. Now, I don't want in the traditional IRA, I'm going to do a conversion into the Roth IRA, and Congress’ IRS it says, yeah, you can basically do that. Okay. But IRS does have a doctrine saying, basically, you can't combine rules in the tax code to avoid taxes. All right, you can't combine rules in such a way that you're trying to use loopholes. And that's kind of what we're doing with that backdoor Roth and so financial advisors have been very careful over the last decades, leave it in the traditional IRA, maybe for six months, maybe even a year, leave it in there, because you intended to keep it in there. And then later, you changed your mind. Okay, IRS has actually come out and said, no, it's fine so now, we as financial advisors are a little less worried about that, but I just pointed that out. It is a risk.

Matt:

No, that's a great caveat there. I've actually had this happen with my tax preparer, totally different section of the tax code. This was years ago, where he took me through this like, it was weird. I felt like I was in one of those cop procedural shows where it was like, and where were you on the night in question, Mr. Robison. He literally was like, what was your mindset and intent when you undertook this fill in the blank strategy? And it was like, I guess I was… would you say that you were intending to do X and such? And I was like, Yeah, I'd say that would be reasonable. He's a Ha, I've got you. Meaning, it was really important to him to have a coherent story and have that line up with a reasonable interpretation of our intent for what we were going to do tax wise. So great, important caveat noted. But your original point was, these are advanced strategies, eyes wide open.

Mike:

There you go. And the second one, you could do that same thing. Did you intend to have kids? Yes, I did, okay, so here's the strategy for this one, you are young, you got some extra savings. All right, and it's sitting there in a taxable account, you want to grow it tax free, open up a 529, you're the account owner, you're the account beneficiary and put in $15,000, and put it 100% into a diversified index fund portfolio in the stock market, you get 7 or 8% return in 15 years, that will turn the $15,000 into $35,000. So you let it sit there you open the account, put in 15 grand, let it sit there grow for you for the next 15 years, and it turns into 35 grand. At that point, 15 years from now you're making more money you've grown in your career, you have more expenses, so you can't save as much. And you're also above the income limit to contribute directly to a Roth IRA. Okay, but now what you can do is take the $35,000 via the new rule we talked about last episode, and you can transfer money from a 529 into your Roth IRA, subject to the yearly limits this year, it's $6,500, if you're under 50. So if it was this year, you could do $6,500 of the 15 of the $35,000 that it's grown to, you can transfer $6,500, from your 529 into your Roth IRA, and there's no income limit. So even though your income has grown, and you can't do this directly from your income, you can do it via the 529. So that's the strategy is while you've got this extra savings, check it in the 529 now. Let it roll for 15 years, and then use that money to fund your Roth IRA in future years.

Matt:

Alright, quick read back. So strategy number one, name yourself as a beneficiary, open up the account to be named later could be your kid. And strategy number two is bear in mind that you can do this conversion later, you can even adopt that as a strategy at the time understanding that there is a little bit of regulatory risk here that the rules could change. And we talked just very briefly on that last show about these conversions, that you do have other kinds of escape hatches here. Like for example, you could end up not having kids, you can have a nice, you can have a nephew, you could have a cousin. So like there, I'm guessing that it's not bad to have that in mind. Okay, if this doesn't work out, what is sort of plan B or Plan C?

Mike:

Yep, yeah. 100%. And I'm not too worried, yeah, with the caveats in mind. This one, I don't think the IRS is gonna come down and be like, oh, you couldn't do that? Because this is something they said you can do, they want more options for the 529. So I think this is a fantastic strategy. To be honest, the first one is great, and I'm not saying that 15 grand like the first one, you have a child like you can just get started, maybe open it up, put in a couple thousand just to get started on that kind of thing. This is a specific strategy for like, Hey, I'm going to fund my Roth IRA and future years, I'm gonna grow somebody's account tax free, and then roll it over in future years. And it's great if you have the 15 grand sitting around, just open up the account, throw in 15 grand, sit back and relax you know, for 15 years.

Matt:

Yeah. And it's almost worth touching on the flip side of your downside risk, which is, wait, what if I do have kids? What if they actually need this money for college? And like, now I've got 35 grand, it almost begs the question of is the juice worth the squeeze on this because nowadays, for higher-ed, $35,000 doesn't sound like a lot of money. I'll just note that I was in this situation, granted, it was like 30 years ago at this point when I was going into college, but there was just like a little bit of money that my grandparents had left and it had gone through my aunt, and it's a whole, it's a whole backstory there. But the point is, it wasn't factored in as part of my student financial aid. And so this money was sitting there and that became available, unlike normal student aid, to me is a 100% tax on everything you've saved, it's pretty bad. But this money was sitting there and if that was my grandparents intent was that there would be just like a little bit, and you know, it, it kind of paid for my first year of college, and maybe it’s just $35,000 but today's rates, like it wouldn't cover a full first year at some institutions. But it could cover half of it. Like it could get you an eighth of the way there like this seems meaningful to me. And so the reverse downside risk is not that substantial. Yeah.

Mike:

Yeah, definitely. There's, you know, again, everyone's got to look at their situation, like maybe you have a super small family. So you don't have like, you know, brothers, sisters, nieces and nephews, or maybe you have a really big family, like, oh, there's no problem, I'll be able to use this money. You know, whatever it is, this is also something you can use, even if you have kids, Matt, you and I could do this, we could open up another 529, you're allowed to have multiple 529s, so you can open up another one, we could throw in 15 grand, and let it sit around for 15 years. At that point, hopefully, we still need the money and can use the money and we're retired. So then we could just start rolling it into you know, although at that point, you still need earned income recall to roll it in your Roth IRA, you're still you know, bound by those rules. We still need to be working in 15 years.

Matt:

That's where the residuals from this show come, in a third strategy?

Mike:

Well, the third strategy is residuals on the show, you've been getting my checks.

Matt:

I've been getting, I've been sending you to check your mailbox. I'm definitely pretty sure that I put that in the mail. All right. All right, third, third, third, third.

Mike:

You just brought it up, Matt. It's the dynasty trust. So this is called a poor man's dynasty trust because you can put money in there again. So this could be anybody's age range. But let's talk about maybe grandparents, you've saved up money, your retirements looking good, you really believe in education, you want to help out the kids, the grandkids during these tough years, right? The kids are very expensive, as you may have mentioned, so the you know, parents sometimes want to help out their kids and grandkids by doing this. You can set up, you can fund a 529 with a lot of money, you can put up to three, four, almost $500,000 per state per 529 per state. You can put in a lot of money into these things and it can grow even beyond that. So that's the contribution limits. States have contribution limits of hundreds of thousands, we don't talk about money because it's like $400,000-$500,000, but it can grow beyond that. If it happened to you invest it and it continues to grow. That's not a problem. It's just the contribution, so you can and then you let it ride so you can put in hundreds of thousands. Now there's gift taxing, okay, there's gift tax rules and stuff like that, right, but you can put in hundreds of thousands in a 529, invest it have it grow and compound. And remember, you can always change beneficiaries. You can open up new flat 529 and roll it so it's hey, I want to give my son Rick, Rick again, you know, for his kids $20,000 or something. So you can open a 529 and transfer $20,000 from your 529 into that one. So parents, grandparents can, if you have extra savings and education for your extended family is very important. You can massively fund a 529 and use it over future years future generations for funding education expenses.

Matt:

Right? This could literally be an ongoing trust, like you could start this, your parents could start this. And originally the beneficiary is your children, and it could be your grandchildren, and then it could go on and on. That's, you know, it's actually amazing to me. I have a really important question for you when you were younger. We're about to lose like anyone who's under the age of 45. When you were younger, were you a dynasty Dallas or Falcon Crest kind of guy.

Mike:

I don't know any of those my friend.

Matt:

Blake Carrington was Dallas Jr. Yeah, I was a Dallas guy. I was six years old, and I spent a whole summer wondering who shot Jr. Okay. I think I've rebooted them all of those shows now. Maybe the younger generation is like what are you talking about? Like I watched that on Tik Tok yesterday.

Mike:

Oh, yeah. Three second episodes.

Matt:

Yeah. Who shot Jr? I love Tik Tok it’s great. I love Tik Tok, let's check this out young peeps.

Mike:

Yeah. What's cool about this,l a lot of wealthier families will set these trusts up these dynasty trusts, what's great about 529 is that it's click, click, click, you're done. Most of the time, you have these trusts and trustees, and it costs a lot of money and oversight and management for setting up what we call dynasty trust legacy, Family Trust 529s. It’s just click, click, click, boom, you got a 529, you can put in hundreds of thousands, you can even open multiple of them if you had a million dollars that you wanted to like fund, you could do multiple of these things. And then just it's set it and forget it kind of stuff. You know, it doesn't cost money each year, they're very easy to set up very easy to manage. And so that's why they call it the sort of poor man's dynasty trust.

Matt:

Well, and it harkens back to your point about strategy number two is that you do the one where you're intending to do that conversion, right. And you've put in the 15k and you're thinking to yourself, but I've still got more money, we'll set up on multiple, like a second account and set up a dynasty trust and just say, you know what, I don't know what's gonna become of this. But I want to be Blake Carrington, I'm making up that name.

Mike:

It is. I mean, there's so many, there's so many cool things when you start thinking about it. Because even if you had an extra, again, we're saying extra, you've got money in your taxable savings. Maybe you're close to retirement, you've got adult kids, but they don't have families or other significant others yet even. But you could still open a file tonight, put in five grand put in 10 grand, it grows tax free. So if you're, you know, planning for this for your kids anyway, don't wait to have them inherit it when they're sixty when you die, and they're 60 years old, like you can start now with these kinds of things. So it's pretty cool.

Matt:

Yeah, that really is amazing. Alright. This has been super useful to me. I'm honestly like, I'm, I'm sort of excited. In your top 10 we talked about doing an NCAA bracket of your favorite accounts. I don't know, man…

Mike:

529s are moving up.

Matt:

Yeah, they're moving up. Alright, anything else you want to hit on?

Mike:

Wow, that was it. That was good.

Matt:

All right. Well, for Mike Morton, I’m Matt Robison and we'll see you next time.

Mike:

Thanks, Matt. Thanks for joining us on financial planning for entrepreneurs. If you like what you heard, please subscribe to and rate the podcast on Apple, iTunes, Google Play Spotify, or wherever you get your podcasts. You can connect with me at LinkedIn or Morton financial advice.com. I'd love to get your feedback. If you have a comment or question please email me at financial planning pod@gmail.com. Until next time, thanks for tuning in. This recording is for informational purposes only and should not be considered for investment advice. Opinions expressed as our of the date of recording. Such opinions are subject to change. We do not guarantee the accuracy or completeness of the data presented here.