New Tax Rule for 2024: Rollover Up to $35K of Your 529 Funds into a Roth IRA

Here is a question I get all the time: What if I over do it? What if I save too much money in my child’s 529 Plan, or they end up not needing it because of scholarships, career choice, or if they don’t go to a traditional college, or they don’t attend college at all?

Secure Act 2.0 to the rescue!

Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0 was passed into law December 29, 2022. It contained a myriad of retirement plan changes, but in this particular blog post, I will focus on one aspect of it, which now allows funds from 529 Plans to be rolled over to Roth IRA’s, by meeting certain conditions. This new rule solves the issue around saving too much into a 529 plan, or what to do with the 529 plan funds if your child ends up not needing them.

But first, let me clear up a common misconception nowadays when it comes to 529 plans. People continue to assume that a 529 Plan is a “college savings plan”. Oh no, not at all! 529 Plans are “education savings plans” and are now far, far more flexible than ever. 529 Plans are not just for college tuition anymore. Congress continues to expand the definition eligible education costs the 529 Plan funds can be utilized for. See below for a summary of what you currently are allowed to use 529 Plan funds for:

What Can 529 Plan Funds be Used For?

• Tuition fees for eligible educational institutions, including colleges, universities, and vocational schools. (So definitely not limited to traditional 4-year programs.)
• Room and board expenses for students enrolled at least half-time. (So even if your child receives a full-ride tuition scholarship, you can use 529 Plan funds on room and board)
• Textbooks, supplies, and required equipment for educational purposes.
• Computer or technology expenses necessary for education.
• Special needs services related to education.
• Expenses for K-12 education, including private school tuition, up to a certain limit (varies by state). (Whoa! not just for college anymore. You can use the the funds, up to $10,000 per year, for private elementary school and high school now too!)
• Certain apprenticeship programs and qualified student loan repayments. (Vocational education now counts too, and leftover 529 plan funds can be used to repay student loans as well, post-graduation).

So you get the point, 529 Plan funds are very flexible now, not just for college tuition, and might even be expanded further in the future.

How Does the New Roth IRA Rollover Rule in SECURE Act 2.0 Help?

Here is the issue Congress addressed in SECURE Act 2.0: What happens if a 529 Plan beneficiary decides not to pursue higher education or receives other financial aid? The funds saved in a 529 plan may go unused and any gains in the 529 Plan account become subject to income taxes and penalties if withdrawn for nonqualified expenses. Fortunately, they arrived at a solution for that.

Starting in 2024, 529 Plan account holders will have the option to roll over funds, up to a lifetime limit of $35,000, into a Roth IRA for the same beneficiary. Yup, you read that right, a Roth IRA! Anyone who knows me well knows how much I love Roth IRA’s.

Let’s explore how this new rule works and the benefits it offers.

Using this new Roth IRA Rule, under the SECURE 2.0 Act, owners of 529 plans can now transfer funds to a Roth IRA for the same beneficiary, providing an alternative use for unused funds. Here’s how:

1. Conversion Limits: Starting in 2024, account holders can convert up to $35,000 from a 529 plan to a Roth IRA for the beneficiary.
2. Roth IRA Benefits: By converting funds to a Roth IRA, owners can avoid taxes and penalties associated with nonqualified withdrawals from a 529 plan. Additionally, it allows individuals to contribute to a Roth IRA even if their income is too high to qualify for direct contributions.
3. The conversion must comply with annual Roth IRA contribution limits (2023 IRA contribution limit is $6500, and that limit is likely to increase for 2024)
4. The 529 plan must be held for at least 15 years by the beneficiary. (So open an account quickly if you have a newborn, and consider conversions if your child is now a young adult and has had a 529 account for a long time)
5. The converted amount cannot exceed the aggregate contributions made to the 529 plan in the previous five years. (So careful timing around the timing of your contributions is important)
6. Roth IRA conversion is subject to annual income limitations. (This means the 529 plan beneficiary must have enough earned income to cover the conversion amount, so these conversions can get really tricky!)

Let’s Summarize the Key Benefits and Planning Items

1. Flexibility: If the beneficiary doesn’t use all their 529 Plan funds for K-12 or college education, the remaining balance can now be redirected towards retirement savings.
2. Retirement Boost: Unused funds in a 529 plan can grow significantly in a Roth IRA over time, where all future growth is tax-free, providing a retirement nest egg for the beneficiary.
3. Tax and Penalty Avoidance: Converting funds from a 529 plan to a Roth IRA allows account owners to avoid income tax and penalties for nonqualified expenses.
4. Alternative Career Paths: If the beneficiary decides not to pursue higher education, the funds can still be put to good use in a retirement account.
5. Educational Funding Changes: Should the beneficiary receive scholarships, employer assistance, or choose a more affordable school, the converted funds can be utilized for retirement savings.

Conclusion: The new tax rule allowing the rollover of 529 funds into a Roth IRA offers a valuable opportunity for account holders, and helps to reduce the hesitation or worry around “what if I overfund the 529 plan?” concerns. It provides flexibility, tax advantages, and the potential for increased retirement savings for the designated beneficiary. To get ready for this new 2024 tax rule, individuals should consult with a financial advisor and/or tax advisor to explore the benefits of rolling over unused 529 funds to a Roth IRA, and to make sure they can meet all the criteria that allow them to do so. By taking advantage of this new rule, you can ensure a brighter financial future for your child, even if their educational plans, or the projected cost of education, changes over time.