529 College Savings Plan Form
Thanks to a new provision in the SECURE Act 2.0, which was passed by Congress in late 2022, money held in 529 college savings accounts will become more flexible beginning in 2024. Specifically, up to $35,000 in funds held in 529 accounts will be eligible for conversion to a beneficiary-owned Roth IRA account, although several limits apply.
While many have praised this change, saying it’s a good reason to start saving for college in a 529 plan in the first place, some experts say it’s wise to overfund a 529 savings account now if you have the financial means. is also appropriate.
But if you really dig into the fine print of this new revelation from Secure Act 2.0, you’ll see that there are many reasons why the new conversion option is less attractive and impressive than it seems. And this can also create tax related problems.
Will your state allow this?
One of the biggest complexities surrounding 529 plans is that each state has its own rules. And while conversions from 529 education savings accounts to Roth IRA accounts won’t trigger federal income taxes, individual states are not required to allow it.
As a result, some 529 plan owners will not be able to take advantage of this new rule without triggering a state tax issue. This is because an IRA transfer to a 529 plan will be considered an “outbound rollover,” which some states treat as a taxable event.
While no one is sure which states will play along with the federal rules and which will choose to impose a 529 tax on Roth IRA rollovers, California is one state that is likely to impose income taxes on these rollovers. This is based on the fact that the state has not updated its rules to match federal laws regarding 529 plans, including plans built on student loans and the use of 529 plan funds for private K-12 tuition .
Are you curious to know about your state’s rules? Check out this 529 plan guide by state.
Annual contribution limits apply
Another “fine print” item on the 529 plan to Roth IRA conversion option is the fact that annual IRA contribution limits apply. The Internal Revenue Service (IRS) sets limits on how much individuals can contribute to an IRA each year, and that limit is set at $6,500 for 2023 (or $7,500 for individuals age 50 and older). And that limit is only increasing to $7,000 by 2024.
This means that, even though you can transfer up to $35,000 from a 529 plan to a Roth IRA in the account beneficiary’s name, it will take you about six years to do so if the account beneficiary is under the age of 50. .
This could mean if someone has extra 529 funds they don’t want to waste it and they’re trying to create Roth IRA funds for the beneficiary to use in their retirement, but five on this goal. Have to spend more than a year. Reaching the $35,000 threshold will require a lot of focus and discipline that many people do not have.
No IRA investments during transfer years
Since the amount that can be transferred from an eligible 529 account to a Roth IRA each year is limited to annual contribution limits set by the IRS, you shouldn’t be surprised if account holders won’t be able to add money to their account. through other means during that year. But, what does this mean in the real world?
Imagine you started saving for college for a daughter named Barbara when she was a child and you saved more than enough to cover her college tuition and fees with $35,000 of leftover money in a 529 plan. Had deposited. Once Barbara finishes school and starts her career, you’re ready to move the annual limit of $6,500 each year from a 529 plan into a Roth IRA account in her name.
However, it will take you five to six years to transfer the full amount, and that means Barbara won’t be able to save for retirement in a Roth IRA (or traditional IRA) during those years because her annual limits are already exhausted. . Monopoly on 529 to Roth IRA conversions each year.
Ideally, Barbara would have access to a tax-advantaged retirement account like a 401(k) plan through her new job, but we all know that’s not always the case.
waiting period
Also note that 529 plans must be open for at least 15 years to unlock the option to transfer up to $35,000 of funds to a Roth IRA in the account beneficiary’s name. This means that, if you open a 529 plan for an account beneficiary in 2023, the money will not be eligible to be transferred to a Roth IRA in their name until 2038.
There is a long time to wait for this strategy to become available and it may be a long time before then. And even after waiting 15 years for the opportunity to become available, it will still take five to six years to transfer the entire $35,000 to a Roth IRA (give or take), depending on what the IRA contributions are at that time. Where does the limit fall?
Bottom-line
If you’re concerned about accidentally saving more for college in one of these accounts, being able to convert unused 529 funds to a Roth IRA in the account beneficiary’s name is a nice benefit. However, the limitations of this new option make it less attractive than it probably first seemed.
Not only do annual IRA contribution limits apply, but the 529 plan must also be open for 15 years. There is also the complication that the account beneficiary will not be able to take advantage of the full IRA contribution limits (and potentially any investments in these accounts) during the years when a conversion to a Roth IRA occurs.
These fine print details don’t make this conversion option a bad deal, but they do mean you’ll have to plan ahead to take full advantage.
