Families typically can only cash out 529 plans when no longer needed for education purposes, but from 2024 thanks to the SECURE 2.0 Act they’ll also be able to roll any unused funds into a Roth IRA account.
529s can be an attractive estate planning tool with their complex rules, yet recent changes make them even more so. Here is everything you should know.
What is a 529 plan?
A 529 plan is an investment account designed to help save and invest money specifically for higher education expenses. There are two primary types of 529 plans: education savings accounts and prepaid tuition plans, both of which grow tax-deferred with withdrawals tax-free provided they’re used to cover qualified education expenses like tuition, fees, books, room and board, computers or special equipment for students enrolled at least half-time at an accredited college or university.
An important thing to understand about 529s is their account owner’s wide latitude of action when using, changing or withdrawing money from them, Biar states. That includes moving funds directly to another beneficiary or even converting to a Roth IRA.
Under a provision in the $1.7 trillion federal spending bill passed late last year, 529 plan owners can start rolling over their unused education funds into Roth IRAs beginning January 2024. While this represents a significant enhancement for some users, it also comes with limitations that must be considered carefully before taking this route.
How can I roll my 529 plan into a Roth IRA?
529 college savings plans offer families an efficient and tax-efficient means of saving for educational costs from kindergarten to graduate school and even apprenticeship programs. Unfortunately, some parents may have set aside too much in savings; any unused funds may become subject to income taxes and penalty fees.
Starting next year, under the SECURE 2.0 Act’s new rule, individuals will have an option to roll unused college savings into Roth IRAs with no penalties attached, subject to certain conditions. Transfers count toward your annual contribution limit of $6,500 per beneficiary and must take place within 15 years.
If you have unspent college funds in a 529 plan, contact your Thrivent financial advisor to explore how transferring them into Roth IRAs may fit into your wealth strategy. As this involves technical rules changes and professional guidance, be sure to seek professional guidance before making the switch. Your advisor can also help determine whether this option would make sense in your situation.
How much can I roll into a Roth IRA?
Parents know children’s minds can change quickly, which makes investing in 529 college savings plans unwise for many reasons. But thanks to a provision in the federal omnibus spending package passed last year, which permits up to $35,000 of 529 funds from existing 529 plans into Roth IRAs starting 2024, that may change.
For a rollover to be eligible, the beneficiary must possess earned compensation that meets or exceeds the annual Roth IRA contribution limit and transfers from 529s must have been in existence at least 15 years; additionally, only limited number of rollovers per year can take place.
Industry stakeholders are still deliberating over some of the implications of this new rule, so details haven’t been finalised; but its effects could make saving easier for families over time and give them options should their child’s educational plans change, while enabling more families to save up more money up front.
What are the tax implications of rolling my 529 plan into a Roth IRA?
College costs have steadily been on the rise. Due to this fact, some may hesitate to start 529 plans for their children or grandchildren for fear they won’t pursue higher education after all or end up with unusable funds that must then be withdrawn and subject to taxation.
SECURE Act 2.0 made several adjustments to 529 plan rules that make it possible to move unused funds directly into a Roth IRA without incurring taxes and penalties – this new rule takes effect next year.
However, it should be remembered that the annual contribution limit to Roth IRAs ($6,500 this year) limits how much can be transferred each year into one. Furthermore, the individual making the transfer must also be designated as beneficiary for both accounts; any contributions or earnings made over the last five years cannot be rolled over into an IRA account.