529 Plan Rollover To A Roth IRA

Making the right investments to help pay for the college education of a child or grandchild presents something of a conundrum. The 529 plan offers tax benefits for college savings, but this useful tool has been underutilized for years. College isn’t necessarily the ticket to success it once was. But with tuition costs increasing 180% from 1980 to 2020, not saving for college guarantees your loved one could end up saddled with student debt, especially since median wages have only increased by 50.4% over the same time period. 

But saving too much for college can be risky as well. A survey conducted by the nonprofit group Educational Credit Management Corporation (ECMC) found that only 51% of current high school students plan on pursuing a four-year degree.

Thankfully, Secure Act 2.0 made important changes to 529 plans that might just help boost their popularity and resolve some of these investor dilemmas.

What Is a 529 Plan?

A 529 is a state-sponsored investment plan with tax advantages that can help you save money for educational costs. Savings in the plan grow tax-deferred, and as long as withdrawals pay for qualifying educational expenses, they're tax-free.

Traditionally, 529 plans went toward saving for higher education, but over the last few years, the program has expanded to include educational costs for K-12 and apprenticeship programs. For K-12 expenses, the IRS limits withdrawals to $10,000 per year.

Anyone can own an account for a beneficiary (e.g. relatives or friends) or contribute to a 529 plan. Another bonus? Accounts owned by non-parental relatives/friends will not have an impact on the student’s eligibility to receive financial aid. There’s also the option to change the beneficiary on the account from one eligible family member to another without penalties or taxes.

Limitations of the 529 Plan

In the past, the tricky part of managing a 529 plan was how to use the money if the beneficiary decided not to go to college. Money in a 529 plan account may only be spent on the qualified expenses, and withdrawals for any other purpose are subject to a 10% IRS penalty. Experts suggest 529 plans were underutilized due to these concerns. 

"Any perceived inflexibility with any financial product can limit participation. A common concern we often hear from potential 529 plan purchasers is regarding the lack of rollover flexibility. People want to know they will not be penalized if their children do not attend higher education," says Chris Lynch, President of TIAA Tuition Financing. 

According to Patricia Roberts, the chief operating officer of Gift of College, there are ways around these perceived limitations.

Secure Act 2.0 Changed the Rules for 529 Plans

The Secure Act 2.0 introduced a raft of reforms to the laws governing retirement in the U.S., as well as the rules for 529 plans. That’s good news that could make it easier for participants to get more value out of 529s.

Secure Act 2.0 directly addressed concerns that money might be wasted if a beneficiary didn’t go to college by permitting Roth IRA conversions for 529 plans. Starting in 2024, the new provision allows up to a lifetime total of $35,000 to be rolled over from a 529 plan to a Roth IRA established in the name of the beneficiary.

Thanks to this change, even if a child doesn’t end up going to college or otherwise making use of the money saved in a 529 plan, you’ve still helped safeguard their financial future and stability by contributing to a 529 plan on their behalf.

What Is a 529 Plan Rollover?

Rolling over funds from a 529 plan to a Roth IRA is subject to the earned income requirements, annual contribution limits, and income limits.

In 2023, you may contribute an annual maximum of $6,500 to a Roth IRA. You or your spouse must have at least $6,500 in earned income and under $138,000 in adjusted gross income for a single filer or under $218,000 for married people filing a joint return.

Income limits and contribution limits will change over time, but under the current rules, it would take you just over five years to roll over the full $35,000 lifetime limit.

If you were a beneficiary of a 529 plan and decided not to attend college, and you started rolling the money into a Roth IRA when you were 18, you would have $35,000 in your account by the time you turned 24.

This change provides a safety net for your child or grandchild's financial future. Even if they choose not to pursue higher education, the money saved in a 529 plan can still be redirected to a Roth IRA, ensuring their long-term financial stability. Understanding the rules and requirements for these rollovers is essential, and it's crucial to stay updated as they may change over time. But with this flexibility, you can empower the young people in your life to make sound financial choices and have a financial cushion as they transition into adulthood.

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