Families concerned they may have been saving too much for their children’s education qualified tax-advantaged tuition “529” plans have greater flexibility and financial opportunities thanks to changes under the SECURE 2.0 Act.
Beneficiaries are now given the option to roll unspent education funds into Roth IRA retirement savings accounts. The ability to convert 529 plan funds to a Roth IRA provides more options for utilizing educational savings and generating long-term, tax-free growth.
Under the old regulations, leftover funds that were not withdrawn and used for qualified educational expenses were subject to income tax on the earnings portion of the withdrawal as well as a 10% penalty. The potential penalties were widely considered impediments to the broader adoption of 529 college plans.
Parents were concerned about children who might not be interested in pursuing higher education or who may not need the 529 funds if they qualified for attractive financial assistance. Some families invested conservatively or bypassed 529 plans altogether.
Retirement Savings Opportunity
The ability to make tax-free transfers of unused educational funds into retirement savings, starting in 2024, will make 529 plans more attractive to plan owners (typically parents) and beneficiaries (usually their children).
However, there are several restrictions that plan owners and beneficiaries must understand:
- The Roth IRA must be in the name of the beneficiary, not the plan owner.
- Rollovers are subject to annual Roth IRA contribution limits. For 2023, this amount is $6,500.
- There is a lifetime rollover limit of $35,000 that can be transferred from a 529 to a Roth IRA.
- The 529 plan account must have been open and held for the designated beneficiary for at least 15 years.
- Rollover funds cannot exceed the contributions to the 529, or earnings on those contributions, made in the previous five years.
Families With Multiple Children
Families with multiple children often fund separate 529 plan accounts for each child. Under the old rule, parents could transfer any leftover funds in one child’s account to another child, thereby sharing the education savings among their children. While this remains an option, parents should consider the new 529 transfer rule before transferring funds between accounts.
Under the new 529 transfer rule, a tax-free transfer can only be made into an account of a designated beneficiary that has been maintained for at least 15 years. The IRS has not yet issued guidance on whether changing the beneficiary of a 529 plan from one child to another resets the 15-year clock.
One option is for the plan owner to request a rollover of funds from one child’s account to another while leaving the initial account open in the name of the original beneficiary, thereby avoiding a potential reset of the 15-year clock.
Potential State Tax Consequences
If a proposed rollover occurs between accounts established in different states, plan owners also need to investigate potential state consequences.
One example of these consequences is clawbacks of deductions taken in the state from which funds would be transferred. Such clawbacks may not preclude a rollover, but owners should understand and plan for any state tax implications.
If you have questions or need guidance on the tax advantages and implications of converting a 529 plan to a Roth IRA, feel free to get in touch with us.
