It’s important for families to start saving for children’s college expenses early as tuition costs continue to rise dramatically. The most common arguments against starting 529 plans is: What happens to the funds if the child doesn’t attend college or if the child gets scholarships, grants, or other financial aid? Can that money be used elsewhere? The recently passed SECURE 2.0 Act provides a new rule that will allow transfers from 529 College Savings Plans to the beneficiary’s Roth IRAs starting January 2024 without taxes or penalties. That is a very beneficial option for unused funds.
Advantage of the New Rule
Prior to the new rule, if the beneficiary of a 529 plan completed their education without fully depleting the assets, there were limited options available for using the remaining funds. The most common approach is to change the account beneficiary to another member of the family to use for qualified educational needs. Another option allows the withdrawal of a maximum of $10,000 to pay towards qualified education loans of the beneficiary. Finally, leaving the worst for last, withdrawing the funds for nonqualified use which would result in those earnings being included in the gross income of the beneficiary plus a 10% penalty applied to those earnings.
The new 529-to-Roth IRA transfer rule allows for greater flexibility with savings in a 529 plan as it removes the dilemma of unwanted tax consequences from overfunding a plan.
Limitations of the New Rule
The Secure Act includes limitations that deters families from using the new 529 rule as a wealth-transfer vehicle, including:
- The lifetime maximum that may be transferred from a 529 plan to a Roth IRA is $35,000.
- Transfers are subject to annual Roth IRA contribution limits of $6,500/person in 20203, so for a lifetime maximum of $35,000 the transfer will take 5-6 years to complete.
- The 529 account must have been in existence for at least 15 years. Start early!
- No contributions or earnings on those contributions from the last 5 years may be transferred.
For a timeline covering some of the major new provisions to the Secure Act 2.0, please click here.