How SECURE Is Your Child’s Future?
Whether planning a family or anticipating college expenses, new regulations may influence your savings strategy
By Megan Ryan | March 23, 2020
Saving money for your children’s future can make the terrible twos seem like a walk in the park. The recently passed SECURE Act includes changes that may affect how parents prepare for new arrivals and save for their education. Use these tips to learn more about the new law.
If you’re planning a family
Under the law, individuals may withdraw up to $5,000 of their IRA, qualified defined contribution plan (such as a 401(k) plan), 403(b) plan or governmental 457(b) plan, to help with the costs of giving birth or adopting a child. The funds can be used penalty-free, but the withdrawal will still be considered taxable income until the funds are repaid.* Note that funds can only be withdrawn after the qualifying birth or adoption, not before.
If parents are adding multiple children to their family, the provision allows for $5,000 to be withdrawn per birth or adoption and per spouse.
“Parents should consider all of their options when paying for the expenses of a new child,” said Kimberly Bridges, director of financial planning at BOK Financial. “This is a new option, but everyone needs to consider the long-term consequences of taking money out of a retirement plan, which increases taxable income for the year and decreases the retirement nest egg if not repaid.”
Check with your employer before making this move, Bridges cautioned. Not all companies offer this option.**
If you have college-aged children
Almost every state offers a 529 plan to help save and invest for educational expenses, including tuition, room and board, books, supplies and equipment. The SECURE Act allows for 529 plan funds to also be used to repay qualified student loans. Distributions are limited to a per-person lifetime amount of $10,000.
At first glance, this may seem confusing. While 529s are a way to save for education, your children or grandchildren may not need all of those funds when they get to school. In those cases, Bridges said, 529 assets can be transferred from one sibling to another by changing the beneficiary on the account. But what if expenses have already been paid using student loans? In this instance, up to $10,000 may be distributed to repay one or more siblings’ student loans. She offered two examples:
- Child 1 uses all of the funds in the 529 account but still has outstanding college loans. Then, Child 2 wins a scholarship and doesn’t need the 529 funds. The parents could access $10,000 from Child 2’s account to help repay Child 1’s student loans.
- In another scenario, parents invested in a 529 for their student, but the fund lost some value during a market downturn. The family may opt to take out a student loan, let the market recover and then use the 529 funds to repay up to $10,000 of the outstanding loan balance later.
Another provision of the SECURE Act allows 529 funds to be used for qualified expenses related to apprenticeships. “Some students may want to enter a trade that does not require college,” Bridges said. “The addition of apprenticeships to the 529-eligible education expenses adds to the options for families.”
As always, families should discuss federal and state provisions for their specific 529 plan with their tax advisor.
If your children have unearned income
In 2017, a change in the so-called “kiddie tax” required a child’s unearned income, such as interest, dividends and capital gains, to be taxed at the often-higher rates of estates and trusts. The SECURE Act reverts back to the prior method, which calculates children’s taxes based on their parents’ tax rates.
“This change will not impact all families, but children with unearned income over $2,200 will be taxed,” Bridges said. “This applies to children under 18 or students up to 24 years old.”
For all of these changes, Bridges encourages parents to consult their financial planner and tax advisor to avoid any unintended consequences.
*Be aware that the repayment option has some restrictions and additional guidance is needed from the regulators on specifics around the repayment process, especially if the participant withdraws from the retirement plan, is terminated or becomes ineligible to continue participation in the plan.
**Retirement plan sponsors are still working through this new option to finalize the process for how this offering will be administered. Additional regulatory guidance is needed before companies can fully implement this option in any particular retirement plan.