By now, you have likely heard about the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) and the SECURE 2.0 Act of 2022 (part of the Consolidated Appropriations Act, 2023). These pieces of legislation were created to encourage Americans to save for retirement and provide additional rules about how retirement accounts should be treated. Among the many provisions in these pieces of legislation, one presents a unique opportunity for young adults to save for retirement.
SECURE 2.0 Act’s 529-to-Roth Rollover
Passed in 2023, the SECURE 2.0 Act provided additional provisions and opportunities to strengthen the retirement system in the United States. One of these provisions includes the ability to roll over unused funds from a 529 plan into the beneficiary’s Roth individual retirement account (IRA), up to a certain amount tax-free and without any penalties.
What Is a 529 Plan?
A 529 plan is a tax-advantaged investment account designed to hold funds to be used for a beneficiary’s (such as a child’s or grandchild’s) qualified educational expenses. After-tax money is placed into the account and grows tax-free through investing. Once the money is needed, it can be withdrawn tax-free for the qualified education expenses of the beneficiary, such as tuition and fees, most room and board expenses, books and supplies, and computers and other technology. The beneficiary can also use these funds to pay up to $10,000 toward their existing student loans. If money is withdrawn for nonqualified expenses, it is subject to income tax and a 10 percent penalty (with some exceptions).
What Happens If There Are Unused Funds?
Getting an education can be expensive, which is why many people are motivated to set up or contribute to 529 plans for their children and grandchildren. Like a standard investment account, money is put into the 529 plan with the hope that it will grow over time and result in enough money to cover some or all of the beneficiary’s educational expenses. If the cost of the beneficiary’s education is less than the amount that has been saved in the 529 account—perhaps the beneficiary has received more in scholarships than they anticipated, for example—there may be funds left over. Now, instead of withdrawing the unused money from the account and paying income tax and a penalty or trying to find a new beneficiary to which you can transfer the remaining funds, the leftover funds can be rolled over into a Roth IRA for the beneficiary.
What Is a Roth IRA?
A Roth IRA is a tax-advantaged IRA to which you contribute after-tax money to be used for your retirement. While in the account, the money grows tax-free through investing and can be withdrawn tax-free after you reach age 59 ½, as long as the account has been open for at least five years. You may be able to withdraw the funds before you have reached age 59 ½ without being subject to taxes or penalties under some exceptions.
Are There Limitations to the Rollover?
Like most things, there are some limits to rolling over unused funds from a 529 educational savings plan into a Roth IRA. Some important limitations include the following:
- There is a lifetime maximum of $35,000 that a 529 beneficiary can transfer to the Roth IRA.
- The 529 plan must have been in existence for at least 15 years.
- The Roth IRA must be in the name of the beneficiary of the 529 plan.
- You cannot transfer contributions or earnings on contributions to the 529 plan that were made within five years.
- Transfers to the Roth IRA are subject to the annual Roth IRA contribution limits.
- The rollover must be plan-to-plan or trustee-to-trustee.
- The beneficiary must have earned income to roll over funds from the 529 plan to the Roth IRA.
Some states do not use the same definition of qualified expenses for state income tax calculations. Therefore, it is important that you work with a professional to understand if there will be any state income tax consequences if you choose to roll over the funds from the 529 plan to a Roth IRA for the beneficiary.
Could This Be the Right Move for Me or My Child?
This new rollover technique allowed under the provisions of the SECURE 2.0 Act presents an additional option to consider if there are funds left over in a 529 plan after you or your child have completed their education. Instead of trying to fund a new beneficiary’s 529 plan or losing part of the money to income taxes and a 10 percent penalty, you may be able to assist your loved one in planning for their retirement. If you have questions about a 529 educational savings plan and how it may fit into your estate plan, please give us a call.
Call Santaella Legal Group, serving all of California, at (925) 831-4840, or reach out to us here.