529 plans have long been a great way for parents and other guardians to save for college. The tax-deferred growth and potential tax-free withdrawals of these plans make them an ideal portfolio option. More recently, thanks to the SECURE Act, 529 plans have become a potential retirement vehicle as well.
Building on that success, several other industry groups now want to expand the usage of 529 plans even further.
This includes using excess funds in a 529 plan for long-term care and elder expenses. Several proposals have been floated and we get another reason to use these plans as a portfolio tool in the near future.
529 Plans & the SECURE Act
Originally created in the late 1990s, 529 plans have quickly become the preferred tuition and higher education funding vehicle for many parents. The plans allow individuals to save tax-deferred and potentially withdraw that money for higher education expenses tax-free. Additional proposals over the years have expanded the usage of 529 plans to include K-12 spending as well as student loan repayment.
However, 529 plans often go underfunded due to the fact that leftover assets in the plans not used for higher education are taxed when withdrawn.
The SECURE Act 2.0 hoped to change that by adding a provision that allows unused funds in a 529 plan to be rolled-over to a Roth IRA for the beneficiary. While there are some restrictions, financial planners and pundits have jumped on the opportunity. Thanks to the ability to change beneficiaries, 529 plans are now seen as a ‘back-door’ retirement savings tool for many families.
A Possible Additional Use
However, what do you do if you’re a grandparent already in retirement and your grandchildren have already gone to college? The problem is that 529 plans directly impact Medicare and long-term care spending/potential. That’s a huge issue considering the graying of America and rising long-term care costs.
According to the Department of Health & Human Services, America’s aging population is setting itself up for an elder care crisis. The agency predicts that 70% of all Americans over the age of 65 will require some sort of long-term care in their lifetime. Just over half will require extensive care, including skilled nursing facilities or those provided in a residential senior living community. Of those people, 20% will need it for five years or more. 1
That’s a problem considering the costs for these services. Most people believe that Medicare, Medicaid, or private health insurance will cover long-term care costs. But that couldn’t be further from the truth. Medicaid will provide some help, but only after other assets and other income restrictions are met.
This comes directly into contact with 529 plans. Since they are considered an asset of the investor, they must be spent down before Medicaid and other programs are enacted.
The issue? As a non-qualified expense, investors face tax consequences including the extra 10% penalty on non-qualified withdrawals.
Industry group Argentum wants to change that.
Through a new report and some lobbying on Capitol Hill, Argentum—which represents assisted living centers—has proposed that leftover funds in 529 plans be allowed to be used to help pay for long-term care. Funds could be withdrawn without taxes and other penalties after a certain age to help pay for care itself or private insurance needed to cover these costs. 2
Currently there are three bills in the House/Senate that look at long-term care funding. This includes two bills that would allow health savings accounts (HSAs) to be used to buy long-term care insurance and regular insurance, as well as one bill that allows for a $2,500 tax-break for those using workplace retirement plans or IRAs to pay for long-term care insurance premiums. Argentum argues that 529 plans should be part of the conversation.
Often parents or grandparents are stuck with leftover funds in these plans with no recourse except to take the taxes on them. Rolling them over may not be the best strategy given the requirements of the process outlined in the SECURE Act. Items like the 15-year shot clock and the ability to only roll-over $10,000 in total may not make sense for many savers. But allowing these funds to directly be withdrawn for care does.
Another Great Use for 529 Plans
While Argentum’s proposal is still in its infancy and the other bills are currently still stuck in committee, it underscores just how the 529 plan is quickly becoming a vehicle for more than just education. Long-term care planning and elder care costs are a significant burden many savers need to face. Being able to tap these plans to cover these costs is beneficial, particularly when considering the tax and Medicaid implications. There’s a good chance that Argentum’s proposal or one similar actually becomes law.
In the meantime, the easiest thing to do would be to set up a 529 plan. Even if you don’t have children or grandchildren, you can open one and name yourself as a beneficiary. If your state offers an income tax break on contributions, it’s best to go with that plan.
By default, most 529 plans use a target date fund for the age at which a child would attend college. However, that may be too conservative if you are planning on using these assets into the future for retirement or potential long-term care planning. Changing that to a different fund may be best. Most plans offer a full range of stock and bond options with many now including low cost index funds.
Ultimately, the idea is to get out in front of any changes to the tax code that would allow 529 plans to be used for additional purposes. Moreover, opening one and funding it today starts the 15-year shot clock for the SECURE Act’s provisions.
The Bottom Line
Thanks to the SECURE Act, 529 plans have emerged as a vehicle not just for higher education. A new proposal would allow even more use including long-term care options. While the plan is still in the works, it just goes to show that 529 plans are quickly emerging as a financial planning tool and that investors should consider opening one even if it’s for themselves.
