The New Changes for 529 Plans: Roth IRA Contributions & Potentially Funding Your Child’s Retirement

by | Mar 29, 2024

The 529 College Savings Plan is a state-sponsored savings strategy designed to encourage saving for future education costs. You can contribute to any state-sponsored plan and it may be advantageous to do so due to other plans lower fees and investment choices. The account holder of a 529 Plan can receive a state income tax deduction on contributions (only if they contribute to their state-sponsored plan which may not be worth it depending on the state plan) and invest funds that will grow tax-free if used by the beneficiary of the plan (future student) on qualified education expenses. 

 

Qualifying educational expenses can include:

Tuition and Fees of Colleges and Universities  Qualified
Vocational and Trade School  Qualified
K-12 Private or Public Schools  Qualified, limited to $10k per year
Books and Supplies  Qualified for college only
Room and board  For college only and enrolled at least half-time
Student Loans  Lifetime limit of $10,000 

 

At the end of 2022, Congress passed the SECURE 2.0 Act made many changes to retirement plans, retirement savings, and amended some of the rules around 529 Plans. It’s a common concern that 529 Plan Funds will go unused by their children or grandchildren even as the cost of college skyrockets as enrollment in universities is declining. 

 

Before the SECURE 2.0 Act, 529 Plan funds were only to be used for qualifying education expenses. If you were to make a withdrawal from the account for non-qualified expenses, you would be subject to both federal and state income tax and pay a 10% penalty on earnings (contributions can be withdrawn tax-free). If your student/beneficiary decided not to attend college, the only way to use the funds without the penalty would be to change the beneficiary to another child or future student for their benefit. The beneficiary must be an eligible family member, otherwise the transfer could be considered a non-qualified withdrawal and subject to taxes and penalties. 

 

The SECURE 2.0 Act brought a major change to the 529 Plan rules that can help most account holders feel more confident with their investments. If the beneficiary decides not to use their 529 funds for qualified educational expenses or they have an excess of funds, they can now rollover funds into a Roth IRA that will allow the contributions to grow tax-free for their retirement savings or other qualifying distributions. 

 

Rollovers from a 529 plan to a Roth IRA will be subject to Roth IRA annual contribution limits ($7,000 for those under age 50  in 2024) and a lifetime cap of $35,000 per beneficiary. There are some limits and things to consider first:

  1. There are a lot of gray areas to this new rule and 529 Plan sponsors are having a hard time implementing it isn’t clear if all states will treat these rollovers as qualifying expenses. 
  2. There is a 15-year holding period, which means you need to have owned the 529 plan for at least 15 years before you can take advantage of a rollover to a Roth IRA (to start the clock, open one now and deposit at least a $1 if you don’t already have a 529 account opened). 
  3. It is unclear, but likely, that the 15-year holding period could restart after a beneficiary change. More information will be provided by the IRS during the year 2024.
  4. Contributions and associated earnings made to the 529 Plan in the last 5 years before distributions started would not qualify for a tax-free rollover.
  5. The beneficiary of the 529 plan and Roth IRA transfer must have earned income equal to or greater than the Roth IRA contribution (standard Roth IRA contribution rules apply).

 

With these new changes, the 529 Plan opened up its potential to help your kids with more than just college expenses and potentially help fund their retirement. While the 529 Plan rollovers wouldn’t increase the amount anyone is allowed to contribute in a year to a Roth IRA, it could allow contributions that would have otherwise been unqualified for high-income earners. Roth IRA contributions are not allowed at a certain income level, but the rollovers from a 529 plan are not subject to this limitation.

 

If you have a 529 Plan and feel unsure if your savings will ever go to good use, you have an awesome opportunity to help jump-start your kids’ retirement savings. If a 25-year-old has $35,000 in a Roth IRA account balance with the funds invested appropriately for their long-term time horizon and risk tolerance, they could have $1.12million (assuming an 8% average rate of return) tax-free by the time they get to 70 without contributing anything more to the account! That’s what 45 years of compound interest can do for your kids when invested properly. 

 

With the recent changes from the Secure 2.0 Act, 529 Plans are an incredible tool to both prepare your kids for either career success or help them fund their retirement. If you are on the fence about investing in one of these accounts, want help with choosing the right 529 plan, or are wondering how to start preparing to set your kids up for success, let’s chat!

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