Using a 529 plan to save for a child’s education comes with a lot of advantages. All earnings generated by the after-tax investments are tax-free for qualified educational expenses, multiple plans are available in each state, contribution limits are high, and they can be handy estate-planning tools, too.
But there’s one big drawback: What if your kid can’t use all the money or even any of it?
A new rule in the recently signed SECURE 2.0 Act allows 529 plan money to be rolled into a Roth IRA for the beneficiary. The move could be a substantial windfall for some families and even be used as an estate-planning tool.
For more help with 529s or other financial considerations, consider matching for free with a vetted financial advisor.
SECURE 2.0 Act 529 Plan Changes
Ordinarily, money withdrawn from a 529 plan must use for qualified educational expenses and if not, you’ll pay ordinary state and federal income taxes (at the beneficiary’s tax rate) on the money, as well as a 10% penalty. Now, the penalty can be waived if your kid wins a scholarship, gets into one of the U.S. military academies, receives support from an employer or for several other reasons – but that’s just the 10% penalty. You’ll still need to pay the tax bill.
You used to be able to get around that penalty by transferring the account to another beneficiary – even yourself or a spouse – in your family or extended family, including in-laws. But without an eligible recipient to use the money you were stuck paying both the tax and penalty – until now.
The rollover allowance starts in 2024 and comes with several limits. First is that the amount rolled over can’t be more than the Roth contribution limit, which is $6,500 this year. You also can’t roll over more than $35,000 total in the beneficiary’s lifetime. You also can’t roll over contributions or earnings from the past five years.
Another condition is that the 529 plan must have been open for at least 15 years. Experts are unsure whether changing the account beneficiary requires a new 15-year waiting period. Also unknown until the IRS issues rules is whether withdrawals of earnings from 529 plans transferred to a Roth account will be subject to the rule that requires earnings to remain in the Roth account for at least five years.
However, the rollover contributions aren’t subject to the Roth IRA income limits of $153,000 for single filers and $228,000 for joint filers this year. Families who’ve contributed to 529 pre-paid tuition plans – where they purchase tuition credits at the current rates – haven’t had to deal with the issue, since those plans refund only the contributions, which are made with after-tax money.
“Families and students have concerns about leftover funds being trapped in 529 accounts unless they take a non-qualified withdrawal and assume a penalty,” a summary statement from the Senate Finance Committee said. “This has led to hesitating, delaying, or declining to fund 529s to levels needed to pay for the rising costs of education. Families who sacrifice and save in 529 accounts should not be punished with tax and penalty years later if the beneficiary has found an alternative way to pay for their education.”
The Bottom Line
The SECURE 2.0 Act will allow for a tax-free rollover of money to a Roth account. This allows for families to keep the money they’ve saved if their children find a different way to pay for college.
College Savings Tips
- A financial advisor can help families plan for education expenses. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Remember, you don’t have to use the 529 plan from the state you live in. You are able to use whichever plan you think works best for you.
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