I've long been a fan of 529 college savings plans. The potential to tackle one of every family's biggest financial challenges -- getting your kids through school without accumulating a bunch of debt -- combined with some amazing tax incentives and easy-to-use programs make them an attractive choice to save for college.
At the end of 2022, when the Secure 2.0 Act passed, 529 college savings plans became even more intriguing. The new law created a potential synergy between two tax-advantaged savings heavyweights: the 529 plan and the Roth individual retirement account (IRA).
Beginning in 2024, the law creates an opportunity to roll over money from a 529 plan to a Roth IRA. This caught my eye on a personal level, because until my son and daughter decided to pursue advanced degrees, I thought we were going to have a nice chunk of "leftover" 529 savings and might have been able to take advantage of the change.
Here are a few key points to help you understand the new opportunity.
Not Any Roth IRA
When I read the headline, "New law allows 529 to Roth IRA rollovers," I was excited about the possibility of sharing the new law with the many parents who I had told, "Save for your own retirement before college." However, since the new law allows a rollover only to the 529 beneficiary's Roth IRA -- most likely your child's, not yours -- it still makes sense to prioritize saving for your own retirement over saving for your kids' college.
Not a Quick Work-around
Two rules surrounding the rollover make it difficult, if not impossible, to use a 529 as a quick route into a Roth IRA. First, the 529 needs to be open for at least 15 years to be eligible to make these rollovers. Second, contributions made to the 529 within the previous five years are not eligible to be rolled over. These two rules ensure that the law provides an attractive option for longtime 529 plan users, as opposed to an opportunity to funnel money quickly into a Roth IRA.
This 'Rollover' Looks a Bit Like a Contribution
A typical rollover doesn't count toward an individual's IRA contribution limit for the year. However, this 529-to-Roth IRA rollover is included toward and capped by the annual IRA contribution limit. For example, this year if the rule was in effect, a maximum of $6,500 could be rolled over into the beneficiary's Roth IRA. However, if the beneficiary contributed $2,000 to an IRA, the maximum rollover amount for that year would be $4,500. And like a regular IRA contribution, the beneficiary must have earned income equivalent to or greater than any rollover from the 529 into their Roth IRA.
Unlimited Transfers Are Not Allowed
The lifetime maximum that can be rolled over to a beneficiary's Roth IRA is $35,000. Don't let that discourage you, and don't discount the power of time. Let's say you were able to roll over $35,000. At retirement, 40 years later at 8%, you would have $1.86 million. Talk about a fantastic way to jump-start your child's retirement savings.
Don't Withdraw Money from the 529
This type of rollover can only be done from trustee to trustee. You may be familiar with an "indirect rollover," in which you withdraw money from one IRA or retirement account and manually move it to another IRA or retirement plan within 60 days. The 529-to-Roth can be done only without you taking possession of the funds -- from one plan to another.
As you can see, there are quite a few details in making one of these rollovers a reality. When you get to that point, connect with your tax adviser to ensure you are checking all the right boxes. In the meantime, set up or save in your 529 plans with the peace of mind that comes from knowing you have an option to avoid taxes or penalties if all that you save isn't used for education.
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