Big change for moving a 529 Plan to Roth IRA in 2024. If you have education funding needs – it may be time to get after it!
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Every January we make new promises to ourselves. I’ll lose that extra few pounds. We’ll lower our household Debt Rate. We’ll take that family vacation to Italy with the kids. Sometimes we follow through. Sometimes only our intentions make it off the grinder. This new alert is pretty exciting however. Under the “Setting Every Community Up for Retirement” (SECURE) 2.0 Act, the 529 education plan just received a turbo boost. And the good news is much of the hard work is done for us. We just have to step up and take action. Here’s what’s happening and how you can armor up and grab a win for you and yours!
As of January 2024 the SECURE 2.0 Act permits rollovers of a 529 Plan to Roth IRA (Individual Retirement Account). The rollover goes from the 529 account and moves to the 529 beneficiary’s Roth IRA. There are certain caveats of course. Otherwise what fun would it be to deal with the IRS.
So let’s slow this down just a bit. First, a very quick heads up on the 529 and Roth IRA at a high level:
- A 529 plan is a tax-advantaged account that can help you save for college. It’s referred to as “tax-advantaged” because the money that you invest grows tax free in the account (i.e., you aren’t paying taxes on the growth each year). Even better, when you withdraw funds from the 529 plan you do not have to pay federal income taxes as long as you use the funds to pay for qualified education expenses. A win-win in our book!
- A Roth IRA operates in a similar manner. You invest after-tax contributions (i.e., money, cheddar, bacon on which you have already paid taxes) into the account. It grows tax free. When you withdraw money, generally speaking, it is tax free. Another win for you and yours.
Was there a problem with 529s prior to SECURE 2.0?
Well, not exactly. It’s just that previously some people may have felt a little hesitant to participate in a 529 plan. There was always the same lingering question that hung over the 529 plan. “What happens if little Wyatt or little Josephine doesn’t want to go to college?”. Many people would ask the question but not hang around for an answer. In business, this is known as a “friction point”. And it can cause someone to not take action. This inaction can then hurt them in the long run.
Investing in a 529 plan was sort of like going to an art gallery and quizzically staring at a strange painting worth $500,000. You simply weren’t sure if the thing was hung on the wall upside down or not. I mean it seems like art because other people were calling it art (i.e., other parents are investing in a 529 plan). But if you hung the same painting in your garage would anyone still think it was worth half a million dollars (i.e., I’m not sure about this 529 thing)? That odd piece of art, like a 529 plan, was surrounded in just enough confusion to make some folks just stare at it. And never take action.
So now we can roll over some of a 529 plan to Roth IRA. I dare say some of the friction around investing in a 529 plan has certainly been reduced.
What’s a rollover?
A rollover is simply when money leaves the 529 plan and goes to a new home. There are actually a few types of rollovers. But here we are sticking with the rollover to a Roth IRA. In this instance we are talking about when money leaves the 529 plan for a specific beneficiary. It then gets transferred to a Roth IRA that is owned by that 529 plan’s beneficiary. This can be done tax-free and penalty-free now.
Example please:
Let’s say you have a son and a daughter, Virgil and Allie, respectively. Dad owns the Alpha 529 plan and Virgil is the beneficiary. Mom owns the Beta 529 plan and Allie is the beneficiary. So far, so good.
A Roth IRA is opened up for Virgil. So Virgil is the owner of that account (not the parents). A Roth IRA is also opened up for Allie. Thus, Allie is the owner of that account.
Dad can do a rollover of the Alpha 529 plan (again, Virgil is the beneficiary of that one) into Virgil’s Roth IRA. This is because the beneficiary of the Alpha 529 plan (Virgil) is also the owner of the Roth IRA (still good ‘ol Virgil).
What Dad cannot do is a rollover of the Alpha 529 plan (where Virgil is the beneficiary) into Allie’s Roth IRA. This is because now we would have a different 529 beneficiary and Roth IRA owner. This will surely disrupt the space-time continuum and cause the flux capacitor to explode.
How much can get rolled over?
The amount that you can roll over into the Roth IRA has a limit. It is subject to the IRS rules for Roth IRA contribution limits. So let’s start there. For 2024, the maximum amount that one can contribute to a Roth IRA is $7,000 (or $8,000 if you are age 50 or older). Just remember that you have to have earned income equal to the amount that you transfer to the Roth IRA for the year.
One other item to note. There is a $35,000 lifetime limit per beneficiary when doing the rollover from the 529 plan to the Roth IRA.
Example please:
Let’s say you have $9,000 in a 529 plan. The plan is for your 16 year-old son Wyatt (the beneficiary). He will attend O.K. Corral University in a few years. However, your in-laws have now decided to pay for Wyatt’s college bill. That sweet mother-in-law of yours. You want to transfer his 529 plan monies into a Roth IRA. This will give Wyatt a great head start on retirement. Wyatt delivered newspapers all summer and earned $10,000 each summer. This is well over the Roth IRA contribution limits. Wyatt does not currently make any contributions directly to the Roth IRA. What does the 529 plan rollover look like:
- Year 1 – 2024: rollover/transfer $7,000 (the Roth IRA contribution limit for 2024) from the 529 plan to a Roth IRA in Wyatt’s name.
- Year 2 – 2025: rollover/transfer the remaining $2,000 ($9,000 was the original 529 plan amount – $7,000 = $2,000) from the 529 plan to a Roth IRA in Wyatt’s name.
Another example please:
Sure. Same situation as above. Except during Year 1 Wyatt contributes $2,000 of his newspaper delivery earnings directly into his Roth IRA. What does the 529 plan rollover look like:
- Year 1 – 2024: rollover/transfer $5,000 from the 529 plan to the Roth IRA in Wyatt’s name. Recall, the maximum contribution for 2024 for Wyatt is $7,000. He has already contributed $2,000 from his earnings directly into his Roth IRA. Thus, we can now rollover another $5,000 from his 529 plan until he hits the $7,000 maximum.
- Year 2 – 2025: rollover/transfer the remaining $4,000 ($9,000 was the original 529 plan amount – $5,000 = $4,000) from the 529 plan to the Roth IRA in Wyatt’s name. Since Wyatt made no direct contributions to his Roth IRA from his newspaper delivery earnings in Year 2, he is free to rollover the remaining dollars in his 529 plan.
What’s the catch – there always seems to be a catch?
Deep breath. There isn’t really a catch. There are just some rules within which we need
to navigate. Two rules in particular:
- First – and most importantly: the 529 account must have been open for at least 15 years. If you change beneficiaries on the 529 plan at any time, the 15-year clock may start over. I’m going to circle back to this 15-year rule in a bit so stay tuned.
- Second: the monies that you rollover (whether principal or earnings) must have been in the 529 plan account for the previous 5 years.
We love when Federal Agents do something now, that gives them options later. So think about it this way. What if you rolled over $7,000 per year over a 5-year period ($35,000 cap). An you started doing this when your 22 year-old graduated from college. By the retirement age of 67, the amount will have grown to $644,995. This is assuming a 7% annual growth rate. And that’s without any further contributions. That’s quite a lot to squirrel away when trying to get a head start on retirement for your kiddo!
What else should I be asking about this?
Good news – your income is not a factor in a 529 to Roth rollover. Roth IRA contributions have income limits. Meaning, if you make over a certain dollar amount then your ability to contribute to a Roth IRA is reduced. It’s eventually eliminated. However, regardless of income you can still perform the rollover from the 529 plan to the Roth IRA for the beneficiary.
Additionally, there are still a lot of questions surrounding the new legislation on this topic. The IRS has yet to put out any clarifying language as of this writing. For example, what if the beneficiary on the 529 plan changes? Does that really start the 15-year clock all over? Also, is the lifetime rollover limit of $35,000 going to be indexed for inflation? Are there any state tax consequences for the rollover? Especially if we received a tax deduction from our home state for the original 529 plan contribution? How exactly does one account for the age of the “earnings” in the 529 plan? Are they more than 5 years old or less than 5 years old?
Good news again – I don’t think you or I really need to know these answers today. Yes, there will be a segment of you that are standing on the cliff of this decision. As in “Do I do a rollover tomorrow or not?”. And for that population of folks, I’d say get with your financial professional(s) in short order. However, for most of you just starting out the key here is to notate the 15-year rule. Again, the language in the statute is pretty clear here. The 529 plan must have been opened for the 15 years prior to the rollover. This is key! Yes, there will be questions about the details. But since we don’t have those at the moment, don’t sweat them right now.
Remember personal finance is in fact, very personal. But think about if a 529 plan makes sense for your family (e.g., graduate school for you or your spouse, college or trade school for the kids, etc.). If you’ve been procrastinating, then now may be the time to get in the fight! This new feature of the 529 plan, while not completely dialed in just yet, can give you some flexibility in your financial planning. Since the 529 account has to be open for at least 15 years, get moving and give some serious consideration to opening one today!
Heads up here – the least expensive way to open a 529 plan is to do it yourself. There are advisor-managed 529 plans but they are unnecessarily expensive. You can always ask a professional about which state 529 plan to select and how to invest the funds, but please consider taking the DIY approach to your 529 plan. A few minutes of your own time could save you thousands of dollars in fees!
Be the Hero for You and Yours!
