If you find yourself in a position where everyone you have wanted to assist with the cost of higher education has completed their schooling and there is still money left over, the SECURE 2.0 Act has just created a new, attractive option for what to do with those funds.
The new law lets owners of 529 college savings plans redirect unused dollars to a tax-free Roth account. Investors can roll up to $35,000 from a 529 into a Roth IRA starting in 2024. The move morphs leftover money originally intended for a child’s college costs into retirement dollars, all without sticking the owner or beneficiary with a tax bill. Roth IRAs are a well-liked retirement savings vehicle because of their tax-free growth and withdrawals.
Let’s breakdown the two savings vehicles we are discussing here.
A 529 plan is a state sponsored college savings plan that is typically set up by a parent or grandparent for a younger family member. Contributions to the plan are made on an after-tax basis and are invested in mutual funds or exchange traded funds. When the funds are pulled out to pay for qualified education expenses there is no tax-bill. If the funds are used for non-educational expenses, the owner pays ordinary income tax and a 10% penalty.
Previously, if a 529 owner was stuck with money in a 529 plan for any number of reasons the only way to get the funds out was to pay a tax bill. Now, up to $35,000 can be seamlessly rolled over into a Roth IRA tax-free if the 529 account has been in existence for at least 15 years. Contributions and growth from the past five years cannot be rolled over.
A Roth IRA is retirement savings account which is funded with after-tax dollars. Once the owner reaches age 59 ½ and has had the plan for at least five years withdrawals can be made tax-free. In 2023 an individual can contribute up to $6,500 to a Roth IRA (subject to income limitations) plus an additional $1,000 if 50 years or older.
The new law lets savers sidestep those income and contributions limits, but only for the rolled-over amount. When it comes to putting future money into a 529-turned-Roth, savers are still subject to the income and contribution limits.
The option to roll the funds into a Roth IRA will give 529 beneficiaries a leg up in saving for retirement. Assuming a conservative, long-term return of 6%, $35,000 in a Roth could grow to more than $150,000 after 25 years, and to over $268,000 after 35 years. This rollover provision is an excellent way to pass wealth onto the next generation in a tax-efficient manner.