This new law takes effect next year. Here’s what you need to know to prepare.
Parents and other family members no longer need to worry about what happens to their child’s 529 plan if they have a remaining balance upon graduation or if they decide not to pursue post-secondary education at all. Historically, parents may have been hesitant to contribute to this education savings account due to the uncertainty of their child’s future decisions, missing out on tax-free growth and withdrawals when used for qualified educational expenses (tuition, fees, books, supplies, room and board, etc.) and in many states, receiving a tax break for contributions made.
Currently, the following options are available when a leftover balance remains in a 529 plan:
- Transfer to another family beneficiary, including yourself.
- Use for a graduate degree, trade school, or other eligible institution of higher education.
- Apply up to $10,000 toward student loan debt or K-12 tuition expenses (per beneficiary).
- Withdraw the funds, face a 10% penalty, and pay income tax on the investment gains.
Fortunately, with SECURE Act 2.0, starting in 2024, the remaining 529 balance can be transferred into a Roth IRA for the same beneficiary, giving them the opportunity to have decades of tax-free growth for their retirement – a very impactful opportunity when factoring in time and compounding growth. A Roth IRA can also be used to pay for a first-time home purchase (up to $10,000 lifetime limit).
There are several circumstances that must be followed, meaning this strategy may not work for everyone.
- The maximum limit that can be rolled over is $35,000.
- The 529 account must have been established for 15 years, so recently opened 529 accounts are not eligible. Contributions (and earnings on those contributions) within the last 5 years also do not qualify for the rollover.
- The annual IRA contribution limit applies (in 2023 this amount is $6,500), so it will take several years of transfers to reach the $35,000 maximum.
- The Roth IRA must be in the name of the beneficiary on the 529 plan, not the account owner.
Each state determines its own 529 plan rules (SECURE Act 2.0 is federal law), so you will need to monitor your individual state’s requirements leading up to 2024, as well as stay tuned for any federal clarification from Congress or the IRS.
With this new provision, I expect to see more parents, grandparents, and other family members utilizing the 529 plan for college savings. If a previous concern was that the child would not attend college or may receive significant scholarships, this approach provides a great backup plan that gives the beneficiary a powerful head start on saving for retirement. However, with the high cost of post-secondary education, most beneficiaries end up using the majority, if not all, of the 529 account balance for qualified educational expenses or the beneficiary is transferred to a sibling or other family member.
This new opportunity should eliminate fears for most of over-saving for their child’s education. If you were on the fence about opening a 529 plan before, this may be the push you need to start investing for your child’s future, remembering that the account needs to be open for 15 years before the Roth IRA transfer is applicable. You can pick a plan from any state, but many states offer a tax deduction for using their plan if you live in that state. Start by determining if you qualify for a state tax deduction, and if not, research different states’ plans to understand their fees, investment options, and account providers to determine the right fit for you and your family.
Source: Levine, J. (2023, February 1). SECURE Act 2.0: Later RMDs, 529-To-Roth Rollovers, And Other Tax Planning Opportunities. Nerd's Eye View | Kitces.com. Retrieved February 21, 2023, from https://www.kitces.com/blog/secure-act-2-omnibus-2022-hr-2954-rmd-75-529-roth-rollover-increase-qcd-student-loan-match/