FROM TUITION TO RETIREMENT: SECURE ACT 2.0 CHANGES TO 529 PLANS

Starting in 2024, under certain conditions, 529 account holders can transfer up to a lifetime limit of $35,000 to a Roth IRA for the 529 plan beneficiary.   But, of course, there are some restrictions and rules surrounding this exciting update.

July 22, 2024

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In a perfect world, you would know the amount needed for all your young scholars’ educational needs, and you would have that exact figure in a 529 plan. That’s not always realistic, however, as sometimes plans change and it’s hard to predict the exact figure needed for educational expenses.  Thanks to the Secure Act 2.0, some of the worries surrounding overfunding 529 plans have been diminished.  Starting in 2024, under certain conditions, 529 account holders can transfer up to a lifetime limit of $35,000 to a Roth IRA for the 529 plan beneficiary.   But, of course, there are some restrictions and rules surrounding this exciting update:

• The 529 plan must have been maintained for more than 15 years. So, you are not allowed to just open a 529 account and immediately be eligible to do a rollover to a Roth IRA.
• The Roth IRA must be in the name of the 529 beneficiary; you are ineligible to send funds from a 529 plan for one beneficiary into a Roth IRA for someone other than the 529 plan beneficiary.
• Contributions made within the last five years (including earnings on those contributions) are not allowed to be used for this tax-free transfer. Unfortunately, you cannot deposit funds into a 529 plan and immediately transfer them to the beneficiary’s Roth IRA.
• You are capped at transferring the current maximum IRA contribution limit each year, and there is lifetime maximum of $35,000. For 2024, the maximum IRA contribution limit is $7,000 for someone under 50.

I know it’s tempting, but you cannot do the full $35,000 at once! You are capped at the lesser amount of either the 529 plan beneficiary’s earned income or the $7,000 max (for 2024).

• Remember, to be eligible to for a Roth IRA contribution, the beneficiary must have earned income (not investment or passive income, they need to have compensation – think wages, etc.). This same “earned income” rule applies here to transfers from 529 plans to the beneficiary’s Roth IRA.  If your recent graduate only earned $4,000 for the year, then you are capped that year at transferring only $4,000 and not the maximum $7,000 amount.
• Yet, unlike a traditional Roth IRA contribution, there is no income cap for the rollover from a 529 plan to a Roth IRA. For 2024, an individual/single filer with over $161k in MAGI would be ineligible for a traditional Roth IRA contribution.  Good news for high-earning graduates, they would be eligible to do the transfer from the 529 plan to the Roth IRA within the annual limit under this new provision.
• Note also that the maximum contribution amount applies to total contributions made between Roth IRAs and Traditional IRAs.
• And, no “double dipping”, you cannot contribute the max to a Roth IRA and do the max transfer of the funds from the 529 funds to the Roth.

Potential Pitfalls

A few sand traps to watch out for:

• Beware that some states may not conform to federal law for state tax purposes, and it is possible that there could be state tax liabilities. So, be sure to consult your tax professional before converting any 529 funds to a Roth IRA.
• It might be hard to track earnings on 529 plan contributions, as it seems that custodians aren’t reporting earnings on each contribution. This could create difficulties when trying to comply with the 5-year contribution rule.
• Also, once you move funds from the 529 plan to the Roth – you lose control to the beneficiary of the Roth IRA! While before you could control the 529 plan (beneficiary changes, investment allocation, etc.), once those funds are in the Roth IRA, you can’t claw the funds back or designate the beneficiaries.  The Roth IRA account holder would have full control over the Roth IRA funds after they have been moved over.

Additional Considerations and Final Thoughts

Don’t forget graduate school – think about other higher education costs your graduate might incur.  And remember, if you have unused funds, you can always change the beneficiary on the 529 plan to another eligible family member, and 529 plans can also create a powerful legacy tool for education planning for the next generation.

While capped at a lifetime limit of $35,000, this new option in the Secure Act 2.0 could alleviate concerns for individuals who have been hesitant to overfund 529 plans.   Einstein coined, “Compound interest is the eighth wonder of the world”, and the ability to convert 529 funds to Roth IRA allows funds to grow tax deferred for a long time and could be a great start to a nest egg for 529 plan beneficiaries.  But, of course, having those funds grow tax deferred in a 529 plan for future generations’ educational needs could also be a powerful legacy asset for future education needs. Make sure that your actions align with your overall “big picture”- decisions should not be made in a vacuum- and please review your situation with your tax, legal, and financial professionals before making an irreversible decision.

Learn More

Want to hear more about this topic and learn about an additional update surrounding third-party owned 529 plans?  Check out our latest Amplified Wealth “According to Plan” podcast.

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RECENT DEVELOPMENT: IRS has clarified that the rollover must be a direct, trustee to trustee transfer that benefits only the original 529 plan beneficiary.   This means that you cannot change the beneficiary, wait 5 years, and then do a rollover from the 529 plan to a Roth for the new beneficiary.  Only the original 529 plan beneficiary can utilize this mechanism, and all the above caveats still apply.