Preparing for the New 529 Plan

Education is a significant investment in a child’s future, and responsible financial planning is crucial to ensure the availability of funds when the time comes. 529 Plans have long been a popular saving choice for higher education expenses, its origin dating back to 1996 when this prepaid college savings account first was added to the IRS tax code. And over the years, there have been changes and improvements to the Plan to make it a more attractive savings vehicle for a family’s college planning needs.

Though now, it appears that Congress has upped the ante with the passage of SECURE Act 2.0 in December 2022. This bill addressed one major stigma of 529 Plans – overfunding an account and ending up with unspent funds when one’s student(s) completed college, subject to penalties if withdrawn. The Act introduced an intriguing option:  the rollover of monies from a 529 account to a Roth account.

UNDERSTANDING THE BASICS

Before exploring the rollover, let’s briefly review the fundamentals of both 529 accounts and Roth accounts.

529 Accounts

A 529 account is a tax-advantaged investment account designed specifically for education savings. Contributions made to a 529 account are not tax-deductible*, but the earnings grow tax-free. Withdrawals from the account are also tax-free when used for qualified education expenses – such as tuition, fees, books, room & board, and student loans. *It should be noted that some states do offer an additional tax benefit for certain contributions made to a 529 Plan; check with your Financial Advisor or CPA for further details.

Roth Accounts

Roth accounts, on the other hand, are known primarily as retirement accounts. Contributions to a Roth account are made with after-tax dollars, meaning there are no immediate tax benefits. However, the earnings in a Roth account grow tax-free, and qualified withdrawals made during retirement are also tax-free.

THE ROLLOVER PROCESS

Now, let’s explore the new provision that permits one to roll over funds from a 529 account to a Roth account.

Caution – Taxable Distributions

When funds are withdrawn from a 529 account for a non-qualified expense, the earnings portion of the withdrawal is subject to income tax and a 10% penalty. Therefore, before considering a rollover, it’s important to ensure that the funds in the 529 account won’t be needed for educational expenses.

Rollover to a Roth IRA

Once it is determined that a rollover is viable, the funds can be converted to a Roth IRA. The new rule permits 529 Plan beneficiaries to roll over up to $35,000 over the course of their lifetime – from a 529 account in their name to a Roth IRA in their name.

Monies rolled over from a 529 plan into a Roth IRA account will be subject to the Roth IRA annual contribution limits. For example, the contribution limit for 2024 is scheduled to be $6,500 ($7,500 for those age 50+, per the catch-up allowance). So, it might take up to 5-6 years to complete a 529 Plan rollover to a Roth account.

Rules You Should Know

• This new rollover provision becomes effective and allows beneficiaries to begin 529-to-Roth rollovers after December 31, 2023.
• A beneficiary’s 529 account must have existed for a period of 15 years before a 529-to-Roth rollover can be performed (penalty and tax-free). Changing the beneficiary of a 529 Plan will restart that 15-year clock.
• Neither 529 contributions, nor the earnings on contributions, that were made (or earned) in the last five years may be rolled over to a 529 Plan.

Benefits of a Rollover

Flexibility: By rolling over funds from a 529 account to a Roth account, the money is no longer tied exclusively to education expenses. This provides an opportunity for funds to grow tax-free for other purposes, such as retirement. And if necessary, there still is a certain Roth provision that permits account owners to make a tax-free withdrawal for education.

Estate Planning: Rolling over funds from a 529 account to a Roth account can be an effective estate planning strategy. Unlike 529 accounts which have ownership restrictions, Roth accounts have more flexibility in terms of beneficiaries. This allows parents to designate their children, grandchildren or others as beneficiaries and pass on assets tax-free to their heirs.

Investment Options: Roth accounts offer a broader range of investment options compared to 529 accounts, which typically are limited to a small selection of investment portfolios or mutual funds. The ability to select from a larger spectrum of investments within a Roth offers the opportunity for greater portfolio diversification and potential safety/growth.

The Bottom Line

This new provision is a huge change for college planning, giving comfort to parents that an overfunded 529 account may not be met with unwanted taxes and penalties. But other significant opportunities exist…

• If you currently have a 529 established for your child(ren), we should talk. You might be able to increase the benefits of this new provision.
• If you haven’t established a 529 yet for your child(ren), we definitely should talk. We’ll show you how to establish your accounts properly, maximizing the benefits of this provision.
• And if you don’t have children, this provision still might provide you a little-known tax opportunity, let’s talk!

 

This material is for informational or educational purposes only.

Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.

Diversification does not guarantee profit nor is it guaranteed to protect assets.

Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.

Past performance does not guarantee future results.

Consult your financial professional before making any investment decision and always consult an attorney or tax professional regarding your specific legal or tax situation.