In 2024, a significant hurdle will be removed for tax-advantaged education savings plans, commonly known as 529 plans. Currently, if your child did not pursue higher education or utilize all the funds in the plan’s account, your only option would be to change the beneficiary to another child or face penalties upon withdrawal. But now there is a favorable new option for leftover funds. In one of the provisions brought by the Setting Every Community Up for Retirement Enhancement Act 2.0 (SECURE 2.0), individuals gain the ability to roll over unused Section 529 funds into a Roth individual retirement account (IRA).
Currently all fifty states and the District of Columbia sponsor at least one type of section 529 plan. Section 529 plans are tax-advantaged saving plans that were created to encourage saving for higher educational expenses. The purpose of a 529 plan is to allow parents, grandparents, etc. to contribute funds that can grow tax-free and be withdrawn without incurring federal taxes when used for qualified educational expenses.
Prior to this new provision families with an overfunded 529 plan could have large sums of money set aside for education with no beneficiary to use the funds. For parents to use the funds they would have to take a non-qualified distribution which would trigger federal income tax and a 10% surtax on the earnings attributable to the withdrawal. Similar taxes and penalties might also apply at the state level. As a result, parents are hesitating or not funding 529s to levels needed to pay for education expenses as these costs only continue to climb. Section 126 of SECURE 2.0 eliminates this concern by not only eliminating tax and penalties, but also by enabling the beneficiaries to begin retirement accounts at an early stage.
Here are the key aspects about the new 529-to-Roth rollover provision effective in 2024:
- The 529 plan must be open for at least 15 years.
- The annual limit on the rollover is the IRA contribution limit for the year, less any other IRA contributions.
- Example: In 2024 the IRA contribution limit will be $7,000. If the beneficiary makes any IRA contributions, the rollover amount must be reduced by those contributions. Thus, if the beneficiary contributed $1,000 to any IRA, the rollover amount available is $6,000.
- The lifetime limit for the rollover is $35,000 per beneficiary. Therefore, it will take several years to roll over the full amount due to yearly limitations.
- The rollover must be to a Roth IRA and be in the name of the beneficiary of the 529 plan.
- Rollover amounts cannot include any amounts contributed to the plan in the preceding five years.
- The rollover must be a plan-to-plan or trustee-to-trustee rollover. This means you cannot take a check from the 529 plan to deposit into the IRA.
- The beneficiary is not subject to income limitations to contribute to a Roth IRA.
- Example: if the beneficiary’s income is over $161,000 (if single), the beneficiary can still make a rollover from the 529 plan to the Roth IRA
A prudent tax planning strategy when a child is born is to establish a 529 plan as soon as possible, so that when the child is 16 years old, the funds will have matured in the plan for the required 15 years. Then once the child is earning a part-time income, the parents can start moving 529 funds to a Roth IRA. Taking advantage of this rollover can be helpful especially in situations in which the child is awarded scholarships or education expenses are less than originally anticipated. As a result of the new provision, a recommendation is to increase 529 contributions, recognizing the presence of a financial cushion to promote savings and capitalize on tax incentives. It’s worth noting that grandparents and other relatives can also capitalize on funding or superfunding a 529, leveraging a provision allowing contribution equivalent to 5 years of the annual gift exclusion amount without beneficiaries incurring gift taxes.
In conclusion, the new provision brought by SECURE 2.0, Section 126 makes 529 plans more attractive than ever before as it introduces what can be interpreted as a $35,000 over-contribution buffer for families and provides a mechanism for parents and relatives to make early Roth IRA contributions to beneficiaries.
Eileen Curran, CPA
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