3 Reasons Why RMDs Make Great 529 Contributions
Do you have a plan for required distributions from your retirement accounts? You can keep your money working toward the future by funding a 529 education savings plan for a loved one.
College costs are rising, so families are looking at all available options to help pay for future education expenses.
Retirees can minimize future taxes on their retirement distributions by funding tax-deferred education accounts like 529 plans.
Even small amounts can add up over the long run. Starting early can give education investments more time to grow.
Retirement and education are two of life’s most important investment goals, and that’s certainly been true for my family.
The ability to retire is the reward for years of hard work. And getting an education can be the start of a promising future. And even though these are separate life events, retirement and education can be linked.
How? With a unique opportunity for retirees to help boost the education savings for a grandchild or other loved one through required minimum distributions (RMDs).
Roth IRAs do not have RMD requirements since the money was taxed before it was put into the account.
The IRS requires that investors take money—RMDs—out of certain retirement accounts.
You might rely on this money for regular retirement expenses. But even if you don’t need it, the IRS rules still require the distributions. If this is the case, you’ll need to decide what to do. Will you cash it out, add it to another investment, give it to charity or possibly use it to help pay for a loved one’s education expenses?
Let me walk you through how you might use your RMDs to help fund a different kind of tax-deferred account—a 529 education savings plan.
But first, let’s start with a quick review.
RMDs and 529s: The Basics
Required Minimum Distributions. People in Traditional IRAs and employer-sponsored retirement plans must take out a percentage of their balance when they reach age 73. (This change went into effect January 1, 2023. If you turned 72 in 2022 or earlier, you’ll need to continue taking RMDs.)
RMDs can provide income in retirement and allow the government to tax the money instead of it staying tax-deferred indefinitely. Amounts are based on your retirement plan balance and your life expectancy.
529 Education Savings Plans. 529 plans offer tax benefits to help save for education expenses. They originally only covered higher education like college but have been expanded to K-12, apprenticeships and student loan repayment.1,2,3 The earnings grow tax-deferred at the federal and state level and can be withdrawn tax-free for qualified educational expenses.1 Some states also offer a state tax deduction for contributions to a 529 plan.
Three Smart Reasons to Use RMDs to Fund 529 Plans
Most of us have heard about the rising cost of college. So, if you must take a distribution and are unsure of what to do with the money, consider keeping it working for the next generation.
The average cost of college in the United States is $35,551 per student per year. That cost has doubled since 2000, with an annual growth of 7.1%.
Source: Hanson, Melanie. "Average Cost of College & Tuition," Education Data Initiative, April 3, 2023.
Review why helping fund a 529 with an RMD may be a good move.
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 put in a 529, 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 year, you can automatically move your RMD to a 529. You can take the distribution in a lump sum or divide it into monthly, quarterly or semiannual payments throughout the year—whatever works best for you and your student.
You can also take the RMD from one account or split it among several, and you can put the money into one or more 529s.
3. Understand Contribution Options and "Grandparent 529s"
There are two basic ways to give to a 529. Your choice and timing may impact the student’s financial aid eligibility4, so it may be best to consult a tax advisor before you start.
Student 529. You can move your RMD to the student’s 529 account (owned by the student or their parent, with the student as beneficiary). If the parent was named the account owner when the account was established, the money is considered the parent's asset and used in financial aid calculations. Withdrawals for education expenses don’t count as income and are not taxed.
"Grandparent 529." You can put your RMD into an account owned by you with the student as the beneficiary. Current rules state the assets are subject to financial aid calculations when withdrawn and given to the student. The money is considered untaxed income for the student and can affect need-based financial aid.
Be on the lookout for future Department of Education changes that will no longer require grandparent 529 distributions to be reported or impact a student’s financial aid eligibility. This is planned to be in place for the 2024-2025 school year; however, other pending legislation could delay this rule change.
Source: Flynn, Kathryn. "What to Know About the 529 Grandparent Loophole & New FAFSA," Saving for College, December 28, 2022.
A Little Can Go a Long Way
Even gifting small amounts can add up over time. And starting early may give the investment more time to potentially grow and compound. 529 plans generally require small minimums and have high limits for the flexibility to gift 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.
You can turn an obligation into a gift for their future.
Non-qualified withdrawals are subject to federal and state income taxes and a 10% penalty.
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.
SECURE 2.0 Act: How the New Retirement Bill Affects You, March 17, 2023.
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.
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.
Please consult your tax advisor for more detailed information regarding the Roth IRA or for advice regarding your individual situation.
Taxes are deferred until withdrawal if the requirements are met. A 10% penalty may be imposed for withdrawal prior to reaching age 59½.
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.