Three years had passed since the original Secure (Setting Every Community Up for Retirement Enhancement) Act of 2019 brought with it several long-awaited changes rules around retirement saving including raising the age of required minimum distributions (RMD’s) and eliminating age limits for traditional IRA contributions. The Consolidated Appropriations Act of 2023 was signed into law in December of 2022 and includes dozens of retirement-related provisions collectively known as Secure 2.0. One of the retirement-related provisions included in Secure 2.0 that goes into effect in 2024 is the ability to make tax- and penalty-free rollovers from 529 college savings plans to Roth IRAs.
529 Plan Considerations
In 1996, Congress enacted Section 529 of the Internal Revenue Codes establishing federal tax rules for 529 college plans. However, it was not until the Economic Growth and Tax Relief Reconciliation Act of 2001 made qualified distributions tax-exempt that the use of these plans really started to grow.
The benefits of using 529 plans include tax-deferred growth in the account and the tax-free distributions for qualified higher or secondary education expenses. The 529 plan owner also controls the account and can change the designated beneficiary at any time. These benefits, including keeping control of the contributed funds, have made funding 529 plans a widely used higher education planning tool.
One of the common concerns when discussing funding 529 plans is “What happens to the money if my (insert: son/daughter/nephew/niece/grandson/granddaughter) does not go to college or a trade school or doesn’t use all of the money?”
Prior to the Secure 2.0, the options were to either change the 529 plan beneficiary to a family member that would use the funds or simply close the 529 plan and distribute the funds. The catch was that any distributions from the 529 plan that were not used for qualified higher or secondary education expenses were included as taxable income for the owner in the year taken and subject to a 10% penalty. The potential income tax and penalty liability have led many to lean towards underfunding 529 plans.
529 Plan to Roth IRA Rollovers
The ability to make tax- and penalty-free rollovers from 529 plans to Roth IRAs will go into effect in 2024. This new option for unused or excess funds in 529 plans can help alleviate over-funding concerns and provide a new retirement planning consideration. We should not be surprised that this new option comes with a number of rules and restrictions including:
- The 529 plan must have been maintained for 15 years or longer
- Only contributions and earning attributable to contributions made more than 5 years ago are eligible to rollover
- The Roth IRA receiving the funds must be in the same name as the beneficiary of the 529 plan
- Rollovers count toward annual contribution limits to Roth and Traditional IRAs
- The beneficiary must have earned income of at least equal to the amount rolled over in a given year
- There is a lifetime rollover limit of $35,000
- Income limits for Roth IRA contributions do not apply to 529 plan rollovers
The list of rules guiding tax- and penalty-free rollovers from 529 plans to Roth IRAs isn’t too onerous but does raise some considerations.
The fact that 529 plan to Roth IRA rollovers count toward annual Roth and Traditional IRA contribution limits will mean that it would take several years to reach the lifetime rollover limit of $35,000. The 2023 Roth or Traditional IRA contribution limit is $6,500 if under age 50 and $7,500 if age 50 or older.
The rule stating that 529 plans must be maintained for 15 years or longer will influence some to simply open and minimally fund a 529 plan just to start the 15-year clock. This is like what many do with Roth IRAs to start the clock for the Roth IRAs own 5-year rule.
I would expect some future clarification on these rules as many have raised questions that aren’t exactly clear from the legislation as it was originally passed. For example:
- Does the lifetime rollover limit of $35,000 by 529 plan or by beneficiary?
- As a beneficiary of multiple 529 plans, can I receive a total of $35,000 Roth IRA rollovers from each of the 529 plans?
- Can I rollover a total of $35,000 to the current beneficiary, change beneficiaries, and then rollover a total of $35,000 to the new beneficiary?
- Do I have the option to change the beneficiary to myself or my spouse and then rollover a total of $35,000?
These questions will eventually be answered and, since the option for 529 plan to Roth IRA rollovers doesn’t go into effect until 2024, there is some time for these to be sorted out.
Like most aspects of retirement and tax planning, many parents, aunts & uncles, and grandparents choose to manage higher education funding considerations themselves. For those who would like some unbiased help, my financial planning service includes retirement and tax planning services that encompass the complex and ever-changing retirement savings rules.
If help deciphering and navigating the dozens of retirement-related provisions of the Secure 2.0 is of interest to you, click here to schedule a time to talk.
