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college, but now expanded to K-12 education). 529 earnings grow tax-deferred at the federal and state level and can be withdrawn tax-free for qualified1 educational expenses.2 Some states also offer a state tax deduction for contributions to a 529 Plan (see map).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.

  • Related Articles
  • More From Author

Learn the Essential Terms of Paying for College

Learn the definitions of the top terms and acronyms you’ll encounter when saving for and paying for your children's college educations.

Get the Most Out of Your 529

Wondering what qualifies as an eligible expense for 529 plan funds? If you don't need it for room and board this year, you have many great options.

Smart Ways for Grandparents to Save & Pay for College

Learn how grandparents can save and pay for a child's college tuition to minimize negative impacts on financial aid.

    Give and Receive with Accelerated 529 Gifting

    Beyond the tax-advantages afforded by 529 plans, gifting money for college may help fulfill a child's dreams for the future. An accelerated gift may also reduce the benefactor's estate taxes. This can add up to good news for college-bound recipients and gift givers alike.

    529 Plans: Time to Get Educated

    College decisions are hard enough. Don’t let these common 529 myths keep you from getting started.

    4 Reasons Why RMDs Make Great 529 Contributions

    Retired and want to help fund a child's education? Here's how to link two of life's most important investment goals.

      The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

      IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

      This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.

      The availability of tax or other state benefits (such as financial aid, scholarship funds and protection from creditors) may be conditioned on meeting certain requirements, such as residency, purpose for or timing of distributions, or other factors.

      IRA investment earnings are not taxed. Depending on the type of IRA and certain other factors, these earnings, as well as the original contributions, may be taxed at your ordinary income tax rate upon withdrawal. A 10% penalty may be imposed for early withdrawal before age 59½.

      You could lose money by investing in a mutual fund, even if through your employer's plan or an IRA. An investment in a mutual fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.