Moving Money from 529 College Saving Plans to Roth IRAs
529 to Roth IRA
The financial landscape is ever-evolving, and with the introduction of the Secure Act 2.0, there are exciting opportunities for individuals and families to optimize their savings and investment strategies. One notable change is the ability to transfer funds from a 529 plan to a Roth IRA, offering a unique avenue for tax-efficient growth and increased flexibility. In this blog post, we'll explore the key aspects of this financial maneuver, shedding light on the benefits, considerations, and steps involved in the process.
The Secure Act 2.0, an expansion of the original Secure Act, was enacted to address various retirement and savings challenges faced by individuals and families. One of its significant provisions allows account holders to transfer funds from a 529 education savings plan to a Roth IRA without incurring taxes or penalties. This opens up new possibilities for leveraging education savings for long-term financial planning.
The 529 College Savings Plan is an excellent way for parents to save in tax advantaged way for their child's college education. With these plans, you can use after-tax money in a 529 plan and get tax-free growth and disbursement for college expenses by moving 529 money to a Roth IRA.
However, some parents worry that if their child gets a scholarship or other financial aid or does not attend college, the penalties for withdrawing the money will be severe. There is a 10% penalty on the earnings and ordinary income taxes if not used for qualified educational expenses. This can add up to a 34% tax on the earnings if you are in a 24% marginal tax bracket!
From my experience, leftover funds in a 529 plan are not very common. In most cases, the 529 plan is funded too late, so there has to be significant catch-up or insufficient funding. In addition, many parents do not know the actual cost of college since a substantial portion of college expenses is living on or off campus, and 529 plans can cover these expenses.
Many parents worry that the money they place in a 529 plan is not used. However, the new rules of the recently passed Secure 2.0 Act provide some crucial changes that parents should be aware of and will, I'm sure, make these plans even more attractive.
The Secure 2.0 Act passed in December 2022 will make some significant changes to 529 college savings plans that you should be aware of. Starting in 2024, you may be eligible to make a conversion to a Roth IRA from a 529 plan. But there are four essential rule changes that you should be aware of to make this transfer of money from a 529 to a Roth IRA.1
1) The Roth IRA must be named in the account beneficiary's name. So, for instance, if the beneficiary is your son or daughter, the Roth IRA must be in their name. You can change the beneficiary to yourself as the owner of the 529 plan and roll the money into your own Roth IRA.
2) The 529 plan must exist for at least 15 years. This rule prevents those just opening a 529 plan and then rolling the money into a Roth IRA. Also, any contributions and earnings made in the last five years are not eligible for the Roth IRA rollover.
3) You are limited in how much you can roll over to a Roth IRA per year by the annual Roth IRA contribution limit. For instance, if the contribution limit in 2024 is $6,500 for a Roth IRA for the year, this is the maximum contribution from the 529 plan to the Roth IRA. So, the maximum that can be moved to a Roth IRA from a 529 plan for an individual's lifetime is $35,000.
4) There are income limits to contribute to a Roth IRA, but with a transfer from a 529 plan to a Roth IRA, there are no income limits. If you are over the income limits to contribute to a Roth IRA, it can be a complicated process of a backdoor Roth, but with the new rules, you can roll over money from a 529 plan to a Roth IRA regardless of your income.
Steps to Move Money from a 529 to a Roth IRA:
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Review Plan Documents: Familiarize yourself with the terms and conditions of both your 529 plan and Roth IRA to ensure compliance with regulations and avoid any unforeseen issues.
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Contact Plan Administrators: Reach out to the administrators of both the 529 plan and the Roth IRA to initiate the transfer process. They can provide guidance on the necessary paperwork and steps involved.
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Monitor Tax Implications: Stay informed about the tax implications of the transfer and consider consulting with a tax professional to optimize your financial strategy.
The ability to move money from a 529 to a Roth IRA under the Secure Act 2.0 presents a valuable opportunity for individuals and families to enhance their financial planning. By understanding the benefits, considering potential implications, and following the necessary steps, you can take advantage of this new provision to create a more tax-efficient and flexible savings strategy for your future.
Conclusion
The Secure Act 2.0 changes to 529 College Savings Plans will make them even more attractive to parents as a way to save for college and perhaps save money for retirement. But there are many new rules that you need to be aware of as a parent in moving money from a 529 to a Roth IRA. Always consult with financial professionals to ensure that your decisions align with your unique financial situation and goals. Contact me below if you want to learn more about how 529 college savings plans fit into your financial goals.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid federal tax penalties. Individuals are encouraged to seek advice from their tax or legal counsel. In addition, individuals involved in estate planning should work with an estate planning team, including personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation of a specific investment or the purchase or sale of securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.
