There are many benefits to using a 529 plan to save for a child’s education. There are several plans available in all 50 states, contribution limits are high, and all earnings from the after-tax investments are tax-free for qualified educational expenses. They can also be useful estate-planning tools.
But what if your child can’t use all the funds or even any of them? Money from a 529 plan may now be rolled over into the beneficiary’s Roth IRA under a new provision of the recently enacted SECURE 2.0 Act. For some families, the move may result in a sizable windfall; it may even be utilized as a tool for estate planning.
Tax-Free 529 Rollovers to Roth IRAs – SECURE ACT 2.0 Changes – PLAN CHANGES:
Money withdrawn from a 529 plan is typically subject to ordinary state and federal income taxes (at the beneficiary’s tax rate) and a 10% penalty if it is not used for qualified educational expenses. Now, the 10% penalty may be waived if your child receives employer support, is accepted into a U.S. military academy, receives a scholarship, or for a number of other reasons. The tax bill will still need to be paid.
In the past, you could avoid this penalty by moving the account to a different beneficiary within your family or extended family, such as your in-laws, or even to yourself or your spouse. In the past, you were forced to pay the tax and penalty on your own without having a qualified recipient to use the funds.
There are various limits on the rollover allowance, which begins in 2024.
- The amount rolled over in 2024 cannot exceed the $7,000 annual Roth contribution limit (for an individual under age 50) and $8,000 (if over age 50).
- You can’t roll over more than $35,000 total in the beneficiary’s lifetime.
- Contributions and earnings from the previous five years cannot be rolled over.
An additional prerequisite is that the 529 plan has to be operational for a minimum of 15 years. Experts dispute whether a new 15-year waiting period is necessary when modifying the account beneficiary. The IRS has not yet released regulations, so it is also unknown if earnings from 529 plans that are transferred to a Roth account will be subject to the requirement that the earnings stay in the Roth account for a minimum of five years upon withdrawal.
The rollover contributions are exempt from the current year’s Roth IRA income limits, which in 2024 are $161,000 for single filers and $240,000 for joint filers. Families that have paid into 529 pre-paid tuition plans, in which tuition credits are acquired at the current rates, have not encountered this problem because those plans only return the contributions, which are paid with after-tax dollars.
According to a summary statement from the Senate Finance Committee, “Families and students have concerns about leftover funds being trapped in 529 accounts unless they take a non-qualified withdrawal and assume a penalty.” This has caused some to hesitate, postpone, or decide not to fund 529 plans at the levels required to cover the soaring expenses of higher education. Families that make sacrifices and invest in 529 plans shouldn’t be penalized with taxes and penalties years down the road if the beneficiary finds another way to cover their educational expenses.
Money can be rolled over into a Roth account tax-free thanks to the SECURE 2.0 Act. If a child finds another way to pay for college, this enables families to keep the money they’ve saved.
Consult an Asset Strategy advisor today to create a 2024 game plan for using a 529 plan to help your children pay for college. We are happy to help you!
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The information presented here is for informational purposes only, is not to be interpreted as investment, legal, or tax advice, and does not indicate suitability for any particular investor. Please consult the appropriate professional regarding your unique circumstances.
Advisory services are offered through Asset Strategy Advisors, LLC (ASA), an SEC-registered investment adviser. Securities are offered through representatives licensed with Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Insurance is offered through Asset Strategy Financial Group, Inc. (ASFG). ASA and ASFG are independent of CIS.
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