A significant change to 529 plans helps remove a major sticking point
The Secure 2.0 Act, enacted as part of the omnibus appropriations bill at the end of 2022, introduces a significant amendment to 529 savings plans, alleviating a major concern for families saving for college.
By Steve Logan — March 7, 2024
Thanks to the Secure 2.0 Act, a part of the omnibus appropriations bill that became law at the end of 2022, a major concern from many families about saving for college in a 529 savings plan has been eliminated.
Beginning on January 1, 2024, unused funds in a 529 savings plan can be converted to a Roth IRA - free of income tax and penalties.
Prior to this change, money in a 529 savings plan had to be used for "qualified education expenses," such as tuition, books, fees, room and board. In addition to those expenses, you could also change the designated beneficiary of the 529 plan to another child, grandchild or even yourself or your spouse. If you had "leftover" money in your 529 savings plan and simply went to withdraw it, you would generally owe ordinary income tax as well as a 10 percent penalty on the amount withdrawn attributable to earnings.
In recent years some of the restrictions on using money in 529 plans had been eased to include continuing education classes, apprenticeships and even student loan payments (up to $10,000), but this didn't alleviate the concern for all families. With these new changes, families can now convert unused funds in a 529 savings plan into a Roth IRA account - with a few caveats. First, the 529 account has to have been opened for at least 15 years, and no contributions or earnings from the previous 5 years can be transferred. The annual Roth IRA contribution limit, $7,000 for those under age 50, applies, and the maximum that can be transferred is $35,000. Other rules apply as well. To make contributions to a Roth IRA the saver must have earned income, and the contributions cannot exceed that earned income.
With these new changes, families can now convert unused funds in a 529 savings plan into a Roth IRA account - with a few caveats. First, the 529 account must have been opened for at least 15 years, and no contributions or earnings from the previous 5 years can be transferred. The annual Roth IRA contribution limit, $7,000 for those under age 50, applies, and the maximum that can be transferred is $35,000. Other rules apply as well. To make contributions to a Roth IRA the saver must have earned income, and the contributions cannot exceed that earned income.
But even though this option became available earlier this year, some families may want to hold off. As of now, the federal government has not yet issued formal guidelines on 529 to Roth transfers, leaving some questions unanswered. One concern has to do with a change in beneficiary, and if that causes a "restart" to the 15-year holding period. The Pennsylvania 529 has even gone so far as to post a warning on its website about potential ramifications once guidelines are issued.
Since many states also offer a tax break for contributions to 529 plans, it may be worth consulting a tax professional to determine how this transfer could affect your finances.
THESE INTERPRETATIONS MUST NOT BE TAKEN AS LEGAL OR TAX ADVICE. THE U.S. TREASURY MAY ULTIMATELY DISAGREE WITH THEM. THE 529 ACCOUNT OWNER IS SOLELY RESPONSIBLE FOR ENSURING COMPLIANCE WITH THE REQUIREMENTS OF 529 TO ROTH TRANSFERS. PLEASE CONSULT WITH YOUR FINANCIAL, TAX, OR LEGAL ADVISOR FOR MORE INFORMATION.
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