Signed into law in late 2022, the SECURE 2.0 Act is a compilation of several bills designed to improve Americans’ retirement savings options. While many of the provisions in this expansive piece of legislation specifically affect retirement plans, there are several that provide for additional financial planning opportunities. One of my favorites is the provision that permits rollovers from 529 college savings plan accounts to Roth IRAs.

While the new rule is fairly simple – it allows investors to transfer assets from a 529 plan to a Roth IRA tax free – I have found that many advisors and their clients still have questions about how this provision works and how to take advantage of it.

Many of us who have funded a 529 educational savings plan for our children end up with money left over. This could be due to a number of reasons. Maybe your child gets grant or scholarship money, or they go to a public rather than a private school, or perhaps they skip college all together.

Regardless of the circumstances, many individuals are left wondering what they can do with these leftover assets.

A new option for leftover 529 assets

Starting in 2024, SECURE 2.0 provides an option: It allows up to a lifetime aggregate limit of $35,000 from a 529 plan to be rolled over into a Roth IRA tax free, for distributions taken after December 31, 2023. But there are several details advisors and clients need to keep in mind. First, the following requirements must be met in order to be able to make this type of distribution:

• The 529 plan must have been maintained for 15 years or longer.
• The Roth IRA must be owned by the beneficiary of the 529 plan.
• The rollover amount cannot exceed the aggregate amount contributed to the 529 (including investment earnings) over the preceding 5-year period ending on the date of the distribution.
• The annual transfer amount from the 529 to the Roth IRA is limited to annual IRA contribution limits and is reduced by any “regular” Roth IRA contributions made during the tax year.
• The Roth IRA owner must have taxable income at least equal to the amount of the rollover.
• Transfers are limited to a maximum of $35,000.

It’s also important to note that the rollover can’t be done all at once: The most that could be rolled over is $6,500 per year (based on 2023 limits), so this process could take five or more years to complete. But that delay also means that, soon after your child starts her career, she would have a Roth IRA with $35,000 in it that could grow tax free for decades (assuming the account was opened and funded at birth).

Allowing that $35,000 to stay invested from age 25 to age 65 would provide your child with $360,000 to use at retirement and save her approximately $56,000 in taxes compared to a traditional IRA. Further, if she is able to make an annual contribution of $4,000, she could retire with nearly a million dollars ($979,048 to be exact) from that account alone.¹

What a great way to set your child up for success! Not only does this allow parents or grandparents to provide lifetime gifts to their children, help them fund their education, and start funding their retirement, it also encourages good financial habits like making annual contributions to Roth IRAs or other accounts.

I’ll be interested to see how this provision – as well as the new SAVE student loan repayment program, which I wrote about recently – changes the way advisors and clients view 529 accounts and education funding overall. On one hand, this provision could prompt families to fund a 529 at the birth of a child to meet the 15-year requirement. However, based on the new SAVE provisions, some may find that taking out student loans could make more sense.

More funds leftover? Consider these options

One last reminder about leftover funds in a 529 account: Some advisors have asked me, “What can I do with any leftover funds after I’ve rolled over $35,000?”

If there are remaining funds, there are a few options to consider:

• Change the beneficiary to another qualifying family member.
• Use leftover funds to pay off up to $10,000 in student loan debt.
• Save the funds to pay for the beneficiary’s graduate school.
• Make yourself the beneficiary and further your own education.
• Save the funds for a future grandchild.

If none of those options is available and the beneficiary is faced with withdrawing funds from the account, remember that doing so would trigger a 10% penalty on the earnings portion of the withdrawal, in addition to federal, state, and county taxes.

As we near the end of 2023, parents should be aware of the potential opportunities SECURE 2.0 could provide and consult their advisor on how best to take advantage. Whether it’s for kids who are finishing their college careers or those New Year’s babies you’d like to start saving for, your 529 plan could not only help cover education expenses, but also fund longer-term goals in a tax-efficient manner.

 

IMPORTANT INFORMATION

Tax information contained herein is not intended or written to be used, and it cannot be used by taxpayers for the purposes of avoiding penalties that may be imposed on taxpayers. Such tax information and any estate planning information is general in nature, is provided for informational and educational purposes only, and should not be construed as legal or tax advice.

Investors should consider, before investing, whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program.

¹ Calculations assume a 6% rate of return, current age of 25, retirement age of 65, and a marginal tax rate of 25%.