A New Era for Education Planning: Exploring 529 Savings Plans
529 Plan Rollover to Roth IRA under SECURE Act 2.0
As the costs of education continue to increase, it’s important that planning for educational goals for families starts early. The 529 savings plan is one of the best tools for education planning, yet it is still not being used to its full potential despite its numerous advantages. This reluctance might be attributed to the fear of potential penalties associated with overfunding, a risk that previously discouraged many from investing the required amounts early on. Specifically, withdrawals from a 529 savings plan for non-educational purposes traditionally incurred a 10% penalty on earnings.
If this sounds familiar, and the potential of paying penalties has caused you to hit pause, perhaps now is the time to reconsider. Congress heard concerns from investors on this topic and partially addressed them with the passing of Secure Act 2.0 in Dec. 2022. Specifically, Section 126 includes language allowing unused 529 savings plan dollars to be converted into a Roth IRA in the account beneficiary’s name, effective Jan. 1, 2024. It’s great news for investors who were concerned they might overfund their savings plan or that their child would opt not to attend college.
The New 529 to Roth IRA Transfer Rule
More flexibility is always a good thing, and while this alleviates some of the concerns centered around using 529 savings plans for educational goals, there are still several hoops and eligibility hurdles that must be met for the 529 rollover to Roth IRA strategy to be utilized.
Key Eligibility & Criteria for 529 Savings Plans
- From 2024 onwards, individuals with 529 accounts can transfer a maximum of $35,000 to a Roth IRA for a beneficiary as a lifetime limit.
- The 529 savings plan must have been open for 15 years or longer.
- The beneficiary must have an earned income equivalent to the amount you plan to convert to a Roth IRA within the same year.
- Rollovers can only be directed to the beneficiary’s Roth IRA (not to the account owner, typically the parent).
- The annual limit for rollovers into a Roth is subject to the current annual contribution limit, which is $6,500 for 2023.
Thanks to the updated regulations under Secure Act 2.0, 529 savings plans are no longer just limited to education savings. With the new provision for Roth IRA rollovers, these plans can now also be used as a means to establish and grow long-term wealth for future generations. If you desire to leave a portion of your funds to the next generation, you can start this process as soon as your children or grandchildren are born by opening and funding a 529 account for their benefit and not necessarily with the intent to fund education, but with the end goal to transfer those funds to a Roth IRA in their name as early as age 16. The benefit of long-term compounding for your children and grandchildren in a tax-free growth vehicle, like the Roth IRA, could result in a significant sum of money for them later in life.
The Secure Act 2.0 fundamentally alters our perception of the 529 savings plan as an investment tool. Now, there’s a cushion against the guesswork of pinpointing how much a child’s education will cost down the line. It’s like having an insurance policy against overfunding and the tax headaches it can bring. Those who are savvy about these new regulations can turn leftover college funds into a kickstarter for their retirement savings. So perhaps time to reevaluate this instrument’s role in your overall financial plan. Contact an Adams Brown wealth advisor to discuss your education and financial planning goals.