New rules that take effect in 2024 for “529” plans will give owners of such accounts more incentive to fund them and give account beneficiaries a way to jump-start their retirement savings.
But 529 investors should be careful to follow the rules.
One of the provisions of the Secure 2.0 Act, a 2022 law that affects many retirement plans, allows excess funds in these education-savings plans to be rolled over into Roth IRAs tax-free if the Roth belongs to the beneficiary of the 529. Previously, if leftover funds were withdrawn and not used for qualified educational expenses, the 529 owner would owe income tax on the earnings portion of the withdrawal and a 10% penalty would be imposed.
Excess funds, or money left over, in a 529 could be the result of a child winning a scholarship, attending a military academy or deciding not to pursue higher education. The risk of unused money languishing in a 529 plan causes some families to fund their plans conservatively or to not even open an account. Next year’s rule change thus could ease the burden on some 529 holders who worried about over-investing in those accounts.
Follow the rules
The potential boost to young people’s ability to save for retirement, meanwhile, is another benefit of the rule change. “This is a very valuable tool and an opportunity for young people to start a Roth IRA,” says Ian Berger, an IRA analyst at Ed Slott & Co., a tax consulting firm in Rockville Centre, N.Y. “But beware of the restrictions,” Berger adds.
First, the Roth IRA must be in the name of the beneficiary, not the owner of the 529 account (if the two are different). There also is a lifetime maximum amount, $35,000, that can be transferred to the Roth from the 529.
Another restriction: The 529 plan must have been open for more than 15 years. And rollover funds cannot include any contributions to the 529 account and earnings on those contributions made in the previous five years.
Rollovers, moreover, are subject to the annual Roth IRA contribution limit. While the 2024 limit has not yet been announced, the limit this year is $6,500. So it would take a number of years before being able to take full advantage of the $35,000 rollover allowance. Of course, the 529 plan beneficiary must have compensation in the year of the rollover at least equal to the amount transferred.
There are two unresolved issues that still require clarification by the Internal Revenue Service. Both involve what happens when a 529’s beneficiary is changed. The first uncertainty is whether a new 15-year waiting period is established when a 529 account holder changes the beneficiary of the plan. The alternative to “resetting the clock” would be that the waiting period of the previous beneficiary carries over.
The other question is whether the $35,000 lifetime maximum is the total for all rollovers made from an owner’s 529 account or the amount allowable for each beneficiary. Experts generally believe that the $35,000 limit is per beneficiary and that amount can be rolled over to the Roth IRA of more than one person.
This article was prepared and legally licensed for use by AdvisorStream. The Wall Street Journal By Leonard Sloane