A special SECURE 2.0 Act bonus kicked in as of the new year. It’s something all parents need to be aware of. For the first time ever, they can now save for their children’s college education and their children’s retirement at the same time. But there’s an important twist.
It starts with the 529 plan. This college savings vehicle has grown in popularity since states began rolling it out in the 1990s. It presents a way to accumulate funds for educational expenses both quickly and over time. But there’s one problem with it that has vexed parents from the very beginning…
What happens to the 529 money if my child doesn’t go to college?
This has always been the drawback of 529 plans. Once they’re started, the money inside them is captive. It’s not like parents didn’t have choices, it’s just that those choices were rather restrictive.
“There was plenty of flexibility with 529 plans,” says Patricia Roberts, chief operating officer at Gift of College, Inc. in New York City. “When 529 funds are not needed, the account owner remains in control of the account at all times and can choose to: 1. Keep funds invested for the beneficiary to pursue some form of higher education at a later time, or for use by someone else such as a future child of the beneficiary, as there are no time limits for use of 529 college savings assets; 2. Change the beneficiary to another member of the original beneficiary’s family with no tax consequences or penalties. The rather broad definition of ‘Member of the Family’ includes the following relatives of the original beneficiary: son, daughter, brother, sister, stepbrother, stepsister, mother, father, nieces, nephews, aunts, uncles, grandparents, first cousins and more. As an example, if the account owner is a parent of a beneficiary who does not need the funds, the parent can change the beneficiary to themself and use all or part of the account for their own adult learning or change it to another child in the household and use it for their higher education — as they are all a member of the beneficiary’s family; or, 3. Withdraw all or part of the funds for any non-qualified purpose, subject to payment of federal and state tax on the earnings portion of the withdrawal and a 10% federal penalty as well on the earnings — unless the withdrawal is due to beneficiary’s death, disability, receipt of scholarship or attendance at a military academy — in which case tax is owed on the earnings but no penalty is imposed.”
SECURE 2.0 Act addressed the anxiety over potential lost 529 money. You now have an additional option should you no longer need 529 assets for educational expenses.
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What are the new rules for unused 529 funds?
As of January 1, 2024, when you discover you have extra money in your child’s 529 plan, there is a fourth option to select from. You can transfer that cash to a Roth IRA. You can piggyback retirement savings onto your college savings. Of course, there are some basic rules you must abide by before you can do this.
“Starting in 2024, the SECURE 2.0 Act allows savers to roll unused 529 funds into the beneficiary’s Roth IRA without a tax penalty,” says Lawrence Sprung, author of Financial Planning Made Personal and founder of Mitlin Financial in Hauppauge, New York. “There are specific parameters that need to be adhered to before you can take advantage of this change. Be aware that there is a maximum amount of $35,000, as a lifetime limit, that can be rolled from a 529 Plan to a Roth IRA. In addition, you need to have owned the 529 plan for at least 15 years before you can roll over funds, and any contributions made in the last five years before distributions began (including any earnings) are not eligible to be rolled over. You also need to do this strategically as you cannot rollover an amount greater than the annual Roth Contribution amount, which in 2024 is $7,000. So, using today’s limit, it would take you 5 years to roll over the entire $35,000 ($7,000 per year over 5 years). The last thing you need to be sure of is that the beneficiary of the 529 plan must be the owner of the Roth IRA and they must have earned income equal to or greater than the amount they plan on rolling over.”
Got that? There are a lot of caveats there. If you are thinking about using this opportunity either now or in the future, you’ll want to make sure you’ve got good records of your child’s 529 plan.
What information does a person need to determine if they can transfer a 529 to a Roth IRA?
If you started the 529 plan years ago, now is a good time to locate and organize the paperwork associated with it. This may be the responsibility of the parents, or it could be the job of the now adult children who had 529 plans established for their benefit.
“To determine if they can transfer a 529 to a Roth IRA,” says Sean Lovison, founder and lead planner at Purpose Built Financial Services in Moorestown, New Jersey, “a person needs information on the 529 plan’s account history, the beneficiary’s earned income, Roth IRA contribution limits, and the time the 529 plan has been open, as these factors influence eligibility and transfer limits.”
Critical to document before beginning any transfer process are two vital pieces of information.
“To determine eligibility,” says Christopher Johns, founder & wealth advisor at Spark Wealth Advisors, LLC in Jacksonville, Florida, “you would need to ensure the 529 was opened and funded at least 15 years ago. Any money that has not been in the 529 for at least 5 years is not eligible.”
Once you have determined you’re qualified, then what do you do?
How can I transfer a 529 to a Roth IRA?
The process itself is fairly easy.
Shawn Carpenter, chairman & CEO of Stock Alarm in Chicago, says, “To make the switch, you’ll need to: Determine if your state allows 529 plan to Roth IRA conversions because not all do; Contact the folks managing your 529 plan to kick off the conversion process; Complete the paperwork and give them the scoop on your Roth IRA account where the money’s heading; Brace yourself for paying any taxes owed on the earnings from the conversion because they’re taxable; and, Keep an eye on and manage your Roth IRA investments in line with your retirement goals.”
Because the rules are still being written, you’ll need to rely on your service providers to ensure the transfer is done properly. For example, this needs to be a direct transfer from your 529 plan to your Roth IRA. You won’t be receiving a check to deposit.
“Anyone interested in taking advantage of this maneuver would need to contact their 529 plan provider and Roth IRA custodian,” says Kevan Melchiorre, co-founder & managing partner at Tenet Wealth Partners in Champaign, Illinois. “These firms will help guide you through the process, which typically involves paperwork to complete the rollover. It is also important to consult your tax advisor and financial planner to discuss how this may impact your specific situation. Overall, it is a pretty simple and straightforward process.”
Finally, you’ll need to be on the lookout for any guidance provided by the IRS. In addition, be careful to monitor what the state sponsoring your 529 plan has to say. Not all states may treat the transfer as a non-taxable event.
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