The SECURE Act 2.0 created a new provision allowing 529 to Roth IRA transfers starting in 2024. This option improves the flexibility of using 529s and may introduce strategic tax planning opportunities. It also comes with several conditions that limit the use of the tactic. We’ve already been fielding some questions about this new rule and hope the below summary helps those that are funding college savings plans.
529 to Roth IRA rule conditions:
• The 529 plan must have been open for at least 15 years
• The transfer in any year is limited to the annual IRA limit (less any actual IRA or Roth contributions made)
• The lifetime maximum transfer is $35,000
• Contributions to the 529 plan within the last 5 years and earnings attributable to those contributions are ineligible for transfer
• The Roth IRA receiving the funds must be in the name of the 529 plan beneficiary
What does the new law aim to accomplish?
The intent of the law is to allow money that was earmarked for educational costs to be reallocated to retirement savings in the event plans change, for example if a child did not attend college.
What are the main benefits of using a 529 plan to save for college costs?
A 529 plan offers tax-free earnings and tax-free withdrawals if the money is used to pay for qualified education expenses. The owner of the plan maintains control of the money for the beneficiary.
What is the most I can contribute to a 529 plan?
There is no statutory limit. Contributions below the annual gift tax exclusion amount can avoid gift tax reporting. The annual exclusion for 2023 is $17,000. Married persons can make gifts up to $34,000 to one person without gift tax return filing. A special provision called superfunding allows you to contribute up to 5 years of annual exclusions in one year, for a maximum of $85,000 or $170,000 from a married couple in 2023. Superfunding requires a gift tax return filing for informational purposes but does not use any of your lifetime gift and estate tax exemption.
What happens today if 529 plan money is withdrawn and not used on a qualified education expense?
Withdrawals from 529 plans used for nonqualified expenses are subject to income taxes and a 10% excise tax on the earnings portion of the withdrawal. To know the potential impact of the tax and penalty, one needs to identify what portion of a 529 plan balance is from original contributions and what portion is earnings. For a detailed explanation, see “Is The Distribution From My 529 Plan Subject To Federal Income Tax.”
Are there exceptions to the 10% penalty for 529 withdrawals?
Yes, scholarships are an exception to the 10% penalty. Non-qualified withdrawals, up to the amount of the scholarship, can be taken out penalty-free, but you’ll pay income tax on the earnings. Scholarships may effectively turn some tax-free money into tax-deferred money.
Are there other ways to avoid taxation and the penalty on earnings if the 529 plan beneficiary doesn’t need the funds?
Yes, the 529 plan beneficiary could be changed to another qualifying family member, such as a sibling or cousin of the beneficiary, who has their own education expenses. You could also retain the funds for future use in graduate school or professional education. There is no time or age limit, and 529 funds can stay invested until needed.
If I change the beneficiary of an existing 529 plan, will that re-start the 15-year clock that is a requirement of the law?
The text of the law does not make the answer clear. 529 owners who might want to change the beneficiary to themselves to transfer funds to Roth should proceed with caution until there is a consensus on the specifics of the 15-year condition.
Could the 529 beneficiary make an IRA or Roth contribution on their own, and rollover money from their 529 to their Roth in the same year?
Yes, but the total contributed and transferred to the IRA and/or Roth cannot be more than the total annual contribution limit for IRAs and Roths.
Could I rollover $35,000 from a 529 to a Roth all at once?
No. The annual transfer limit is the same as the annual IRA and Roth contribution limit (e.g. $6,500 for persons under age 50 for the 2023 tax year).
Does the Roth owner need to have earned income in the year(s) of the 529 to Roth rollover?
It appears yes. The legislation does not explicitly spell it out, but the underlying rules seem to suggest the Roth owner would need compensation to make the transfer. In other words, a student or child may need compensation from a summer or part-time job if not yet employed full-time. This interpretation could change with guidance from Congress or the IRS.
Does the Roth owner need to be under the MAGI (Modified Adjusted Gross Income) limits to use the 529 to Roth transfer?
No. The law specifically states that transfers from 529 to Roth will not be subject to the same income limitations that normally apply for Roth IRA contribution eligibility.
Could I open a new 529 for a child, or for myself, with the specific intent of using it to transfer to Roth in the future?
Yes, with the caveat that rules could change, and one would need to wait at least 15 years before getting the money into a Roth, and all the conditions described at the beginning of this article.
Could I intentionally over-fund an existing 529 plan, to both pay for college and to help seed a child’s Roth IRA?
Yes, with the same stipulations as noted above.
How much would I need to contribute to a 529 plan today for it to reach $35,000 in 15 years?
Depending on the investment performance, a deposit of $11,000 earning 8% per year could grow to $35,000 in 15 years. At 7% per year, the figure is $12,700 and at 6% per year it is $14,600.
If I am over the income limit to contribute directly to a Roth, how might I approach this new rule strategically to make Roth contributions in the future?
One could open a 529 plan today with a small balance and keep an eye out for any rule changes. If regulations move out of favor, the consequences for a small balance and nonqualified withdrawal are modest. If the 529 rollover to Roth technique is still available, one could contribute more to the 529 later – before the last 5 years of the 15-year period. This might allow additions to Roth for someone who was otherwise not eligible due to income restrictions on direct Roth contributions.
I use the backdoor Roth strategy today. Does the SECURE Act 2.0 matter to me?
The legislation did not change the ability to continue using the backdoor Roth strategy. See our guide “Can I Make A Backdoor Roth IRA Contribution” for more details.
As is often the case with new legislation, there are many questions about how this may function in practice. This interpretation could change with additional guidance from Congress or the IRS. We will provide additional updates as they become available. At Heritage we stay on top of legislation changes so our clients don’t have to.
How else might the SECURE Act 2.0 impact you? Read our blog article and view our checklist, “What Important Issues Should I Consider Regarding Changes Made By The SECURE Act 2.0.”