A New Option for Unused College Saving Plans
College tuition is expensive. College savings plans (also known as 529 plans) offer tax advantages to help families save for tuition and ease the financial burden. 529 savers are preparing for the future! But what happens if 529 funds are not used?
A 529 beneficiary may not use 529 plan funds for many reasons. They may have earned a scholarship (wonderful!), they may have forgone college to pursue their career in another way (fantastic!), or they may have leftover funds after attending college.
In the past, families had few good options for ‘leftover’ 529 funds: they could direct the 529 to another family member, take a non-qualified distribution, or pay off certain kinds of student loans. But the family may want the 529’s intended beneficiary to receive those funds. Afterall, they saved money for their loved one. Taking a non-qualified distribution, or distribution not for education expenses, is less than ideal. These redemptions incur both income taxes and a 10% penalty on the earnings.
A new provision from The Secure 2.0 Act enables a 529 account owner to use 529 dollars to help fund a Roth IRA for the beneficiary. A Roth IRA may create new opportunities. These funds could assist with their first home purchase and eventual retirement.
Of course there are additional caveats and rules:
- You must wait until 2024 to take advantage of this new transfer option
- The 529 account must be opened for a minimum of 15 years
- You are limited to rolling $35,000 into Roth for each 529 account beneficiary
- No earnings or contributions from the previous 5 years can be transferred to the Roth
- Transfers may be subject to the $6,500/year Roth contribution maximum ($7,500 if beneficiary is over 50 years old)
As with any new legislation there are also unanswered questions and considerations:
- Will states tax this rollover? State tax implications are yet to be determined and each state will roll out their own guidelines, but the rollover is tax-free federally.
- Do beneficiaries need earned income equal to the amount contributed each year? Earned income is a requirement for standard Roth contributions. We are waiting for IRS guidance on this point.
- If the beneficiary also has an existing Roth account, the rollover amount needs to be coordinated with their regular Roth contributions to ensure they do not go over the limit ($6,500 or $7,500 depending on age).
- 529 to Roth IRA rollovers will likely be a multiple year process depending on size of account and other factors.
Even with the unknowns, the 529-to-Roth rollover alternative presents another advantageous, tax-favorable solution to the question of what to do with leftover 529 funds.
It’s also a new avenue for grandparents and parents looking for a vehicle to support their heirs through key life milestones – not only education but home ownership and retirement as well.