Moving Money from 529 College Saving Plans to Roth IRAs
The 529 College Savings Plan is an excellent way for parents to save for their child's college education. With these plans, you can use after-tax money in a 529 plan and get tax-free growth and disbursement for college expenses.
But some parents worry that if their child gets a scholarship or other financial aid or does not attend college, the penalties for withdrawing the money are severe. There is a 10% penalty on the earnings and ordinary income taxes. This can add up to a 34% tax on the earnings if you are in a 24% marginal tax bracket!
From my experience, an overfunded plan is not very common. In most cases, the 529 plan is funded too late, so there has to be significant catch-up or insufficient funding. In addition, many parents do not know the actual cost of college since a substantial portion of college expenses is living on or off campus, and 529 plans can cover these expenses.
Many parents worry that the money they place in a 529 plan is not used. However, the new rules of the recently passed Secure Act 2.0 provide some crucial changes that parents should be aware of and will, I'm sure, make these plans even more attractive.
The Secure Act 2.0 passed in December 2022 will make some significant changes to 529 college savings plans that you should be aware of. Beginning in 2024, you may be eligible to move the money from a 529 plan to a Roth IRA. But there are four essential rule changes that you should be aware of to make this transfer.1
1) The Roth IRA must be named in the beneficiary's name. So, for instance, if the beneficiary is your son or daughter, the Roth IRA must be in their name. You can change the beneficiary to yourself as the owner of the 529 plan and roll the money into your own Roth IRA.
2) The 529 plan must exist for at least 15 years. This rule prevents those just opening a 529 plan and then rolling the money into a Roth IRA. Also, any contributions and earnings made in the last five years are not eligible for the Roth IRA rollover.
3) You are limited in how much you can roll over to a Roth IRA per year is your contribution limit for the year. For instance, if the contribution limit in 2024 is $6,500 for a Roth IRA for the year, this is the maximum contribution from the 529 plan to the Roth IRA. So the maximum that can be moved to a Roth IRA from a 529 plan for an individual's lifetime is $35,000.
4) There are income limits to contribute to a Roth IRA, but with a transfer from a 529 plan to a Roth IRA, there are no income limits. If you are over the income limits to contribute to a Roth IRA, it can be a complicated process of a backdoor Roth, but with the new rules, you can roll over money from a 529 plan to a Roth IRA regardless of your income.
The Secure Act 2.0 changes to 529 College Savings Plans will make them even more attractive to parents as a way to save for college and perhaps save money for retirement. But there are many new rules that you need to be aware of as a parent. Contact me below if you want to learn more about how 529 college savings plans fit into your financial goals.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid federal tax penalties. Individuals are encouraged to seek advice from their tax or legal counsel. In addition, individuals involved in estate planning should work with an estate planning team, including personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation of a specific investment or the purchase or sale of securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.
