Dealing With Unused 529 Funds Just Got a Little Easier
By: Kelan Coate, Financial Planning Intern
529 plans are a great way to start saving for college expenses. Contributions are invested on an after-tax basis. The money earned on the investments in the 529 is therefore not taxed when it is withdrawn, so long as the withdrawals are used to pay for the education of the beneficiary. The one potential problem with the 529 plan is what happens to these funds if they are not all needed to pay for the education. If the unused money is withdrawn, it is subject to state and federal taxes and an additional 10% penalty.
With the passage of the SECURE Act 2.0 in December of 2022, a slew of new tax provisions will start to take effect. One of the more interesting provisions has to do with qualified college savings accounts (529 plans). Beginning in 2024, the new code will allow unused funds from a 529 plan to be rolled into a Roth IRA. While there are some rules and limits to this new provision, it would allow some unused 529 plan funds to continue to grow tax-free, and subsequent withdrawals will no longer be taxed as a non-qualified distribution. In addition, A Roth does not have required distributions as a traditional IRA does.
Before making the transfer however there are a few rules that you must be aware of. Those rules include the following:
This new legislature has raised some questions that have yet to be answered by the treasury department. One question is regarding the change in beneficiary of a 529 plan. If you were to change the beneficiary, it is still unclear as to how that would affect the rollover and if the 15-year time period would restart. Additionally, would the clock reset on the 15-year time period if the owner switches the state in which the qualified 529 plan is invested?
While there are still unanswered questions about this process and some things that are unclear, transferring excess funds from a 529 plan into a Roth IRA is an excellent alternative to paying tax and penalties on unused 529 funds. It can also be a great way to help set up a child with a bright financial future and a jumpstart in learning how to save and plan for retirement.
There are several possible strategies parents and their children/beneficiaries can follow to maximize the benefits of these provisions, but you should discuss them with your financial planner and tax accountant.
With the passage of the SECURE Act 2.0 in December of 2022, a slew of new tax provisions will start to take effect. One of the more interesting provisions has to do with qualified college savings accounts (529 plans). Beginning in 2024, the new code will allow unused funds from a 529 plan to be rolled into a Roth IRA. While there are some rules and limits to this new provision, it would allow some unused 529 plan funds to continue to grow tax-free, and subsequent withdrawals will no longer be taxed as a non-qualified distribution. In addition, A Roth does not have required distributions as a traditional IRA does.
Before making the transfer however there are a few rules that you must be aware of. Those rules include the following:
- The Roth that the funds are being transferred into must be in the same name as the beneficiary of the 529 plan.
- The 529 plan must have been maintained for at least 15 years before the funds can be transferred.
- The 529 rollover amount cannot exceed the 529 account beneficiary’s earned income for that year.
- The total amount of the rollover cannot exceed $35,000. This number is also not indexed to inflation, meaning that it will not increase in the future unless the provision is changed. (Total of $35,000 per beneficiary)
- The annual amount of the rollover follows the same rules applied to contributions of all other IRAs. For 2023 this amount is $6,500. This number is indexed to inflation.
- Only contributions and earnings that come from contributions made over 5 years ago are eligible to be transferred.
This new legislature has raised some questions that have yet to be answered by the treasury department. One question is regarding the change in beneficiary of a 529 plan. If you were to change the beneficiary, it is still unclear as to how that would affect the rollover and if the 15-year time period would restart. Additionally, would the clock reset on the 15-year time period if the owner switches the state in which the qualified 529 plan is invested?
While there are still unanswered questions about this process and some things that are unclear, transferring excess funds from a 529 plan into a Roth IRA is an excellent alternative to paying tax and penalties on unused 529 funds. It can also be a great way to help set up a child with a bright financial future and a jumpstart in learning how to save and plan for retirement.
There are several possible strategies parents and their children/beneficiaries can follow to maximize the benefits of these provisions, but you should discuss them with your financial planner and tax accountant.