New legislation has solved a long-time dilemma for parents: What to do with unused funds in a 529 college savings plan.
SECURE 2.0 provides a solution for assets that will not be used for qualified expenses and remain in 529 plans. Beginning in 2024, a provision allows parents to roll over unused 529 assets into a Roth IRA, without taxes or penalty.
Many families start saving when children are young and can sometimes overfund a 529. Students may choose a less expensive school or finish their degree program early. If there are no other college-bound siblings to be named as beneficiaries, families may have to withdraw these unused funds and face federal taxes and a 10% penalty for a non-qualified distribution.
Now parents have another option.
Here are the rules around the provision:
- The total lifetime amount eligible for transfer from a 529 plan to a Roth IRA is $35,000 per beneficiary
- The Roth IRA must be established in the name of the 529 beneficiary (the student)
- Annual contribution limits apply to transfers. For 2023, the contribution limit for IRAs, including Roth IRAs, is $6,500
- The 529 beneficiary receiving the transferred funds in a Roth IRA is subject to the same income requirement that applies to all IRA contributions.
- However, income eligibility requirements that set limits for making Roth contributions do NOT apply. (For 2023, income phaseouts to make Roth IRA contributions begin at the modified adjusted gross income of $138,000 for single taxpayers, and $218,000 for married couples filing a joint tax return)
- The 529 must be established for at least 15 years before you can transfer to a Roth
- Contributions (and earnings) made in the 529 plan during the last five years are not eligible to be transferred to a Roth IRA. This is meant to deter someone from making a large contribution into an existing 529 plan and trying to transfer funds to a Roth IRA immediately to avoid contribution limits
More clarity needed
With any broad-based legislation, we expect to see additional guidance from the Treasury on certain provisions. One question raised already is whether changing the 529 beneficiary would trigger a reset of the 15-year clock requirement for transferring funds to a Roth IRA.
Another question is whether it is conceivable for the parent to change the 529 beneficiary to themselves to transfer the funds to a Roth in their name. Some may want to explore this if their reported income is too high for a regular Roth contribution.
While clarity is still needed, parents can assume with some confidence that they will be able to have a seamless rollover of the unused 529 funds to a Roth in their child’s name.
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