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Secure Act 2.0 – Making (529) Leftovers More Appealing!

| December 19, 2023

If you’ve explored saving for college in any capacity, you’ve likely heard of a 529 account. These accounts offer the potential for tax-free growth when used for qualified educational expenses. Sounds straightforward, right?

Well, in a general sense, yes! But we know from our dedicated work with clients that questions can often arise when it comes to applying general investment opportunities to unique investor situations. (In fact, we wrote a blog purely for 529 questions here!)

In all of the loving preparation for and funding of a college savings account, one important question may be overlooked: What happens if there are funds left over?

Generally speaking, if funds are withdrawn for purposes other than qualified education expenses, any gain is subject to income tax and a 10% penalty. One common option has been transferring the 529 funds to another 529 beneficiary, but that comes with limitations as well (see our other blog post noted above). So what if the original beneficiary goes to a less expensive college or doesn’t go to college at all, and it doesn’t make sense to transfer to another beneficiary?

Good news! As part of the Secure Act 2.0, starting in 2024, 529 account owners have the option of rolling over the funds to the 529 beneficiary’s Roth IRA without incurring a 10% penalty or generating any taxable income. Overall, this is a great benefit for taxpayers who have been saving funds in a 529.

 

To help see how this may apply to your unique situation, here are some key factors to consider before rolling funds from a 529 to a Roth IRA.

  1. The 529 must have been open for more than 15 years.
  2. The beneficiary of the 529 must be the owner of the Roth IRA.
  3. For the beneficiary, the maximum lifetime limit from any 529 that can be rolled over is $35,000. This is subject to annual Roth IRA contribution limits, so the $35,000 can’t be rolled over in one year.
    1. For example, in 2024 the Roth contribution limit is $7,000 for individuals under age 50. Assuming the contribution limit doesn’t change each year, then it would take 5 years to roll $35,000 from the 529 to the Roth IRA.
  4. Like a lot of new legislation, more clarity is needed on the implementation. Some questions include:
    1. Does the 529 beneficiary need to have earned income of at least the amount of the rollover? It appears likely.
    2. What would be the impact of changing a 529 beneficiary? Will you be permitted to change a beneficiary before initiating a rollover? Will changing a beneficiary start a new 15-year holding period?

As a reminder, other options for leftover funds are:

  1. Transferring them to another family member’s 529.
  2. Up to $10,000 of the 529 funds can be used to repay the beneficiary’s student loans (and an additional $10,000 from the beneficiary’s 529 may be used to repay a sibling’s student loans).
  3. If the beneficiary receives a tax-free scholarship the IRS does allow a distribution up to the amount of the scholarship penalty-free (but the earnings portion of the distribution will incur income tax).

For more information on 529s, give our team a call at 270-594-5757 and we’ll be glad to assist!