4 Reasons Why RMDs Make Great 529 Contributions

By Evan Mayhew - November 21, 2018

Retirement and education are two of life's most important investment goals. For retirees who want to contribute to a grandchild's or other student's education, it may make sense to link those strategies. Why? Retirees have a unique income stream that can help boost education savings: required minimum distributions (RMDs).

At age 70½, investors must start taking money—RMDs—out of retirement accounts. After a lifetime of saving, you might rely on that income for regular retirement expenses. But even if you don't need it, IRS rules still require distributions. Then you'll need to decide what to do with the money: Cash it out, add it to another investment account, use it for life insurance premiums, give it to charity or pay for education expenses.

In this article, we'll discuss how using your retirement account RMDs can be a great resource for funding another kind of tax-deferred account: a 529 education savings plan.

Let's start with a quick refresher on RMDs and 529s.

RMDs and 529s: The Basics

Required Minimum Distributions. Investors in Traditional IRAs and employer-sponsored retirement plans are required to withdraw a percentage of their accounts when they reach age 70½. In retirement, RMDs provide income, as well as allow the government to tax the money rather than allowing it to stay tax-deferred indefinitely.

Annual distribution amounts are based on your retirement plan balance and your life expectancy. Read more about RMD rules and account types.

529 Education Savings Plans. 529 plans  were designed with tax benefits, like retirement accounts, to make it easier to save for education expenses (originally college, but now expanded to K-12 education). 529 earnings grow tax-deferred at the federal and state level and can be withdrawn tax-free for qualified1 educational expenses.2 Some states also offer a state tax deduction for contributions to a 529 plan (see map).

Four Reasons to Use RMDs for 529s

Last year, 12 percent of college students used money from grandparents (and other extended family and friends) to pay for education expenses.3 If you have to take a distribution, why not keep the money working for the next generation?

  1. Minimize Additional Taxes
    RMDs are taxable distributions, and if you invest them in another taxable account, the money will continue to be subject to taxes. But if you put the distributions in a 529 account, the money will grow tax-deferred and can be withdrawn tax-free.1

  2. Turn Regular Distributions into Regular Contributions
    Instead of figuring out where to put the money each December, you can make a 529 account the destination for your distribution. Take the RMD in an annual lump sum or divide into monthly, quarterly or semiannual payments throughout the year—whatever works best for your student's savings plan.

    You can also take the RMD from one retirement account or split among several, or you can put the money into one or more 529 accounts.

  3. Flexible Contribution Options
    There are two basic ways to handle 529 contributions, but be warned that your choice (and timing) may impact the student's financial aid eligibility.4 It's best to consult your tax advisor before settling on a contribution strategy.

    The first option is to direct your RMDs to the student's own 529 plan (owned by the student or parent). The money is considered assets of the parents and is used in financial aid calculations. Withdrawals for education expenses don't count as income and are not taxed.

    The second is to invest RMDs in a "grandparent 529." The account is owned by a grandparent (or anyone other than the student or parent) with the student as beneficiary. In this case, the assets aren't subject to financial aid calculations until withdrawn and given to the student. At that point, the money is considered untaxed income for the student and can affect need-based financial aid.

  4. A Little Can Go a Long Way
    Even small contribution amounts can add up over time. Making a commitment early can give your student's savings more time to grow and compound. 529 plans generally require small minimum investments and have high investment limits, giving you plenty of flexibility if you want to give more or less than your annual distribution amount.

    If you've not yet calculated your RMD or estimated how much you need to take in future years, try our Required Minimum Distribution Planner.

Turn an Obligation into a Gift

Ready to plan your current or future RMDs and get your student's future off on the right foot? Learn more about 529 education savings plan options , or call our experienced Investment Consultants today at 1-800-345-2021.

Evan Mayhew
Evan Mayhew

1 Non-qualified withdrawals are subject to federal and state income taxes and a 10% penalty.

2 Beginning in 2018, distributions for educational expenses for elementary and secondary school (public, private, or religious) will be treated as qualified higher education expenses up to an aggregated limit of $10,000 per student. Amounts over that limit will be treated as taxable income.

3 "How America Pays for College 2018," Sallie Mae® and Ipsos.

4 NOTE: This information is only a summary and not intended as advice. You should consult a financial aid advisor or the U.S. Department of Education's website at www.ed.gov for more information about financial aid.

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