We’ve long touted the benefits of a 529 Plan for college savings—savings grow tax-deferred; often there are state tax benefits; the plans have a wide definition of qualified educational expenses; beneficiaries could be easily changed, and so on. One complaint investors have often shared is that once funds are contributed to a 529 Plan, they’re locked in for education purposes only.
While 529 plans have always provided ample opportunities to use or withdraw the money, a provision in the SECURE Act 2.0 now allows account owners to roll over funds to a Roth IRA for the beneficiary. A lifetime maximum of $35,000 can be rolled over; however, annually the rollover is limited to the maximum annual Roth contribution, which is $7,000 in 2024 for people younger than 50. Unfortunately, this new rule comes with several conditions. The 529 Plan account must have been open for at least 15 years, contributions and earnings from the last five years cannot be rolled over, and the beneficiary must have earned income at least equal to the amount of the rollover.
However, before you rush to initiate a rollover, understand that there are some grey areas that the IRS and states need to interpret. Will changing beneficiaries reset the 15-year holding period? Will states accept the rollover as a qualified expense, or will a state assess a tax on the rollover amount? Will a state require repayment of the state tax savings if 529 funds are rolled over into a Roth? Who will be responsible for any potential penalties—the 529 plan owner or the Roth IRA owner?
Since there is no time limit to use funds in a 529 Plan, account owners may want to wait for further clarification before making a decision on a rollover.
Keep in mind that this rollover provision should not be the impetus for funding a 529 Plan. These plans were specifically created to aid with education costs. Nor should investors look at a 529 Plan as something that should be overfunded so a child can have instant retirement savings. Congress merely wanted to add another option for those who have unused funds in a 529 Plan.
Of course, if you do have remaining plan assets, there are a host of options to consider. If your student received a scholarship, you may make a penalty-free non-qualified withdrawal up to the amount of the tax-free scholarship; however, you will have to pay income tax on the earnings. Should your child choose not to attend a traditional two- or four-year college, funds could still be used for qualified expenses for apprenticeship programs, or trade or vocational schools. In any instance, you may save the funds to pay for graduate school; funds can be used in pursuing a certificate, degree, or other recognized continuing education credential; you may change the beneficiary to another qualifying family member to use for their college costs or to help pay for student loans, or you can keep the funds in the plan for future generations’ K-12 tuition and college expenses. You may also make non-qualified distributions, paying a 10% penalty and income tax on the earnings portion of the withdrawal.
If you have questions on how a 529 Plan can help you save for education expenses, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the March 16, 2024 “Henssler Money Talks” episode.
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