Use Your Old 529 Plan to Fund a Roth IRA for Your Kids

Introduction

With the recent changes brought by the SECURE 2.0 Act, there's exciting news for those with leftover 529 plan funds. Starting in 2024, you can roll unused 529 assets into a Roth IRA for the beneficiary without facing tax penalties. This new option provides flexibility for managing your child's educational and retirement savings. Let’s dive into the details and explore how this can benefit you and your family.

What Are 529-to-Roth IRA Rollovers?

529 accounts have long been a popular way to save for college. Now, they offer another benefit: the ability to roll over unused funds into a Roth IRA. This can be a great relief for those worried about having excess funds in a 529 plan if the beneficiary doesn’t need them for educational purposes.

Key Points of the New Provision

The new provision includes several important aspects that families should be aware of:

Lifetime Limit: You can roll over up to $35,000 in unused 529 assets into the beneficiary's Roth IRA.
No Tax Penalty: These rollovers are not subject to the usual 10% penalty for non-qualified withdrawals and won't generate taxable income.
Start Date: This provision takes effect in 2024.
Understanding these key points helps you see the potential advantages and limitations of the new rollover option.

(kid can only contribute up to max yearly based on their earned income)

Understanding the Limits

While this provision opens up new possibilities, there are important limitations to consider. These rules ensure that the rollovers are used appropriately and within the legal framework.

Holding Periods

To be eligible for a rollover, the 529 plan must have been owned for at least 15 years before executing the transfer. Additionally, contributions made within the last five years (including associated earnings) are ineligible for a tax-free rollover.

Annual Limits

The rollover amount cannot exceed the annual Roth contribution limit, which is $7,000 in 2024. Rolling over the full $35,000 would therefore take at least six years under current limits.

Ownership

The beneficiary of the 529 plan must also be the owner of the Roth IRA and have earned income equal to or greater than the rollover amount.

These limitations highlight the importance of planning and understanding the rules to make the most of this new option.

Potential Complications

There are still uncertainties and potential complications that could arise with this new provision. Families should be mindful of these issues as they consider their options.

Changing the beneficiary might trigger a new 15-year holding period, and it’s unclear who would be responsible for penalties if the rollover does not meet the requirements. It's essential to stay informed about any updates or clarifications from the IRS regarding these rules.

Steps to Take Now

While awaiting further clarification, here are some steps to consider to make the most of this opportunity:

For Existing 529 Plans

Before making any changes, it’s advisable to wait for the final rules to be clarified. This ensures that any actions taken are within the guidelines and do not inadvertently cause issues.

For New 529 Plans

When setting up new 529 plans, it’s beneficial to create separate accounts for each child. This approach simplifies the process of rolling any excess funds into your child's Roth IRA later on. Previously, many were cautious about overfunding 529 plans due to their restrictions to qualified higher education expenses. However, with the recent enhancements to 529 plans, there's now greater flexibility. This means there’s no longer a need to hesitate in contributing generously to these accounts unless you’re certain your child won’t pursue college.

Other Options for 529 Funds

If you are concerned about overfunded 529 plans, remember that you can switch beneficiaries to continue using the account for educational purposes. Additionally, up to $10,000 can be used to pay off qualifying student loans, and equivalent amounts can be withdrawn penalty-free if the beneficiary receives a tax-free scholarship (though earnings will be taxable).

These steps provide practical ways to manage your 529 plan funds effectively while awaiting further guidance.

Consider Roth IRAs

Even if you don't have excess funds in a 529 plan, encourage your child to contribute to a Roth IRA if they have earned income from a job. Starting early allows them to harness the time value of money. As Einstein famously said, “Compound interest is the most powerful force in the universe”—and this came from the man who gave us E=MC^2! Time and compounding can work wonders for your wealth, so help your children take advantage of this powerful, tax-free growth opportunity.

Conclusion

The SECURE 2.0 Act offers a valuable new way to use leftover 529 plan funds, but it’s essential to know the rules and use them correctly. This change to the law offers you the ability to set your kids up for success and we encourage you to take advantage of it.

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