Spare change is a beautiful thing, but this is a different type of change. The SECURE 2.0 Act, enacted in December 2022, brought exciting changes for 529 college savings plans. Yeah, that kind of change; the one that gives you a ton more options than many of the limitations of the college savings plans. One of the most significant is the ability to convert unused 529 funds to a Roth IRA under specific guidelines. This opens up new possibilities for families who may have leftover funds or whose beneficiaries may not pursue higher education.
But before you jump ship, let's navigate the details!
What You Can Rollover:
Starting this year, you can convert up to $35,000 in lifetime contributions from a 529 plan to the beneficiary's Roth IRA. This is a lifetime limit, not an annual limit. Shucks, but it's still a pretty sweet deal.
The earnings generated on those contributions are not eligible for the rollover and will be subject to income tax and a 10% penalty if not used for qualified education expenses.
Eligibility:
The rollover can only be made to the beneficiary's Roth IRA, not the account owner's.
The 529 plan must have been in existence for at least 15 years before the rollover can occur.
The beneficiary must have earned income in the year of the rollover to contribute the converted amount. The minimum earned income needs to be equal to or exceed the amount being rolled over.
Tax Implications:
The beauty of a Roth IRA conversion is the tax-free growth on future
contributions. However, there are some tax considerations to keep in mind:
Contributions to a Roth IRA may be subject to income limits.
The earnings on the converted amount within the Roth IRA will grow tax-free if you meet the eligibility requirements for qualified distributions (generally, age 59 ½ and holding the account for at least five years).
Any earnings withdrawn from the 529 plan during the rollover will be subject to income tax and the 10% penalty (unless used for qualified education expenses).
Weighing the Pros and Cons:
Pros:
Tax-free growth: The converted amount grows tax-free within the Roth IRA if you meet eligibility requirements.
Retirement savings boost: This can be a valuable tool for beneficiaries who may not pursue higher education or have leftover funds.
Flexibility: Roth IRAs offer more flexibility in withdrawal options compared to 529 plans. When I say flexibility, it basically means whenever you reach the minimum withdrawal age, do whatever you want with the funds. No taxes and zero penalties.
Cons:
Contribution limits: You're limited to a lifetime rollover amount of $35,000. I can imagine that number growing to adjust to inflation over time. That's still a decent amount and gives parents alternative options for these funds.
Income limits: Roth IRA contributions may be subject to income limits.
Tax implications: Earnings withdrawn from the 529 plan during the rollover are taxed and penalized (unless used for qualified education expenses).
Is a 529-to-Roth IRA Conversion Right for You?
This new option presents an opportunity, but it's not a one-size-fits-all solution. Consider these factors:
Future education needs: Will the beneficiary likely pursue higher education? I would recommend making pretty darn sure they won't use it for college expenses before you start this process. That's where a financial advisor, the parent, and the child can review those choices before you take action.
Alternative uses for 529 funds: Does the 529 plan offer features like K-12 tuition coverage? This choice is growing in popularity as people consider private schools over public education.
Tax implications: Consult a tax advisor to understand the potential tax benefits or drawbacks. There are some things to consider but this new change has been rolled out with some pretty apparent advantages.
Consulting with a financial advisor can help you navigate the specifics of your situation and determine if a 529-to-Roth IRA conversion aligns with your long-term financial goals.
Remember: Knowledge is power! By understanding the rules and implications, you can make informed decisions about your 529 plan and unlock the potential of this new rollover option
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