529 Rollover To Roth

Show Notes

For more than 20 years, 529 education savings plans have helped families pay for qualified school expenses while enjoying a tax benefit in the process. But there was also a major drawback.

• If you’ve ever wondered how 529 plans got their name, it goes back to 1996 when Congress enacted Section 529 of the Internal Revenue Code, allowing states to establish and administer the plans.
• Each state has its own plan, and they have different benefits and requirements, but the common ingredient is that money put into a 529 savings plan grows tax-free and withdrawals for qualified education expenses are also tax-free. The money can be used for grades K through 12 as well as college.
• So it’s similar to a ROTH IRA, in that contributions are not deductible on your federal tax return. However, more than 30 states offer some kind of tax break, so depending on where you live, you could be eligible for state tax deductions or credits if you invest in a 529.
• These plans also offer you some flexibility in case things change. If one child doesn’t use all of the money in the account, the beneficiary can usually be changed later to a different direct relative. In theory, a single account could survive for generations.
• Another nice feature— anyone can contribute— but it’s usually better to have the account in a parent’s name.
• There’s also a potential financial-aid advantage to a 529 plan. The FAFSA form— Free Application for Federal Student Aid— counts money held in 529 plans at a lower rate than money in other accounts. That means money in a 529 plan won’t count against you as much as other assets when applying for aid.
• You can invest in any state’s 529 plan and use the money to pay for an eligible college in any state. So 529 plans are flexible in many ways, but they come with one major restriction: Once you open a 529 account and put money into it, you’ve committed the money for education.
• If you don't use it for eligible expenses, those withdrawals will incur a 10% penalty and will also be subject to federal income taxes on the investment gains. And that’s why more families haven’t taken advantage of 529 savings plans. But all that is about to change as 529 account holders get a new way to rescue unused funds.
• As part of the $1.7 trillion spending package passed last month, money leftover in a 529 savings plan can be rolled over into a Roth IRA without incurring taxes or penalties starting in 2024. That’s a potentially huge development, as it removes a major drawback to 529 plans and will likely encourage more families to open the accounts.
• It’s unclear how much unused money might be transferred from 529 plans to Roths, but in 2021, there were nearly 15 million 529 accounts holding almost $500 billion in assets. That’s about $30,000 per account.
• Critics of the new provision say it’s a handout to the rich because wealthier families are more likely to have 529 plans than lower-income families — and because the provision doesn't carry income limits.
• It does, however, have a number of other restrictions. For one, there’s a lifetime limit of $35,000 on transfers, and rollovers are still subject to annual Roth contribution limits. In 2023 that limit is $6,500, or $7,500 if you’re over age 50.
• Also, like any custodial account, once the funds go in, they become the property of the beneficiary. That means a 529 rollover can only be made to the beneficiary’s Roth account, even though a parent or grandparent may be the owner.
• Most graduates with leftover 529 money won’t be able to immediately roll it over to a Roth. To be eligible, the 529 account must have been open for at least 15 years, and contributions and earnings must be in the account a minimum of 5 years before they can be transferred.
• You want to save as much as possible for education so you can avoid borrowing … remember Proverbs 22:7, “ … the borrower is slave to the lender.” And one of the best ways to avoid borrowing is with a 529 savings plan.
• So if the “unused funds” restriction was preventing you from opening a 529 account … now you have one less excuse. Get started saving today.

On this program, Rob also answers listener questions:

• What should you do after a CD matures?
• When does it make sense to move money into an employer-sponsored ROTH account?

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