The Secure Act 2.0: Making 529 Plans More Valuable
Signed into law late last year, The SECURE Act 2.0 is a piece of legislation that seeks to expand and enhance the retirement savings opportunities for individuals in the United States. One of the provisions pertains to 529 plans, which are tax-advantaged investment accounts designed to encourage families to save for future college expenses. The problem arises when funds go unused—they may end up stranded in your child’s 529 plan, and/or incur penalties if the funds are used for something other than education.
Money Stranded in a 529 Plan?
Say your daughter gets enough scholarship money that she doesn’t use up the full balance of her 529 plan, or perhaps she decides not to go to college at all. In both of these scenarios you have just a few options, and none of them are great:
If your daughter finished college, she may want to use the remainder of the funds in her 529 plan for graduate school. This is the best-case scenario, and funds are used until they are depleted.
You can change the beneficiary of your daughter’s 529 plan to another family member (another child, a grandchild, your spouse, yourself, brother, sister, niece/nephew, etc.). However, it may be difficult to find a relative who (1) wants to go to school, (2) doesn’t already have their own 529 plan, and (3) to whom you want to provide this sort of financial support, so this isn’t as helpful as one would hope.
You can bite the bullet and use your daughter’s 529 plan balance for any non-qualified expenses, in which case they’ll incur the regular income tax rate plus a 10% penalty. Again, not great.
The SECURE Act 2.0 and 529 Plans
Under The SECURE Act 2.0, the rules governing 529 plans have expanded to allow for more flexibility and increased contributions. One new option is the ability to convert a 529 plan into a Roth IRA. Beginning in 2024, 529 plan beneficiaries can transfer 529 plan funds into their own Roth IRA without paying taxes or penalties. Key points:
The 529 plan must have been open for a minimum of 15 years.
The owner of the Roth IRA must be the beneficiary of the 529 plan.
The lifetime limit for rollovers is $35,000.
Contributions made to the 529 plan in the last five years, including the associated earnings, are ineligible for a tax-free transfer.
Transfers you make from a 529 to a Roth IRA count against your yearly Roth IRA contribution caps, which currently top out at $6,500.
Many people ask how they can fund Roth IRAs for their children, but they’re usually out of luck unless a child has earned income. However, this new provision allows parents to not only save for a child’s education but also give them a leg up on retirement savings. The new law provides parents with a wonderful additional retirement savings strategy for children, in addition to a welcome release valve for over-funded 529s.
— Brant Jones, CFP®