If you hesitate to start 529 college savings plans for your young children due to uncertainty about whether your child will attend college or qualify for scholarships and financial aid. However, a recent change in the law aims to address these concerns. Section 126 of the SECURE 2.0 Act introduces a rule allowing distributions from 529 plans to be transferred to Roth IRAs without taxes or penalties. This rule, effective from 2024, provides more flexibility and peace of mind for your family saving for education.

Advantages of the New Rule

Previously, if a 529 plan beneficiary didn’t use all the funds for education, the options for the remaining balance were limited. These options included changing the beneficiary to a family member, using a portion for qualified education loans, or making nonqualified withdrawals with penalties and taxes. The new rule allows for direct transfers to Roth IRAs, enabling your family to maximize the value of your savings and invest for tax-free growth as early as possible. However, there are limitations to prevent misuse of 529 plans as wealth-transfer vehicles.

Understanding the Limitations

The 529-to-Roth transfer rule has certain restrictions:

  1. Lifetime maximum transfer of $35,000.
  2. The 529 account must be at least 15 years old.
  3. No transfers of contributions or earnings from the last five years.
  4. Transfers are subject to annual Roth IRA contribution limits, but there is no upper-income constraint.

Example Scenario

Let’s consider an example to illustrate how the limitations work:

Margo’s 529 plan was opened when she was born in 2000, and contributions were made until she graduated high school in 2018. After completing college in 2022, there was still $33,000 left in her 529 account. Starting in 2024, Margo can transfer funds to her Roth IRA, considering the 15-year requirement and annual contribution limits. She can make yearly rollovers until she reaches the $35,000 limit or depletes the 529 account.

Navigating the Limitations

Different scenarios may affect the rollover strategy:

  1. If the beneficiary has already contributed to an IRA that year, the rollover amount may be limited.
  2. If the beneficiary earns less than the annual Roth IRA contribution limit, the rollover amount is capped by their income.
  3. If the total transfers reach $35,000, but funds remain in the 529, additional rollovers can continue until the account is exhausted.
  4. If the 529 was established less than 15 years ago, the beneficiary must wait until the account meets the requirement.
  5. If contributions were made within the past five years, those funds cannot be transferred until the five-year period has passed.

Removing Barriers to Educational Savings

The new 529-to-Roth IRA transfer rule offers greater flexibility for saving for education by eliminating the need to predict exact college costs. Your family can avoid unwanted tax consequences and potentially jump-start retirement savings using unused college funds.

Understanding and making the most of these rules can empower 529 beneficiaries to make informed decisions about their educational savings.

Saving for college: The new 529-to-Roth IRA transfer rule – Journal of Accountancy

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