The secure act offers new flexibility for unused dollars
Key takeaways
- The SECURE Act offers the ability to rollover up to $35,000 of unused 529 plan dollars to a Roth IRA penalty free.
- The 529 plan must have been established for a minimum of 15 years.
- Contributions within five years are ineligible for Roth conversion.
- The 529 and Roth accounts must have the same beneficiaries.
One of the most powerful gifts you can offer your child or grandchild is the opportunity to graduate from a higher education institution with zero debt. With the cost of a four-year college degree (tuition and fees) currently averaging from $156,000 for an in-state institution to $223,000 for a private institution, walking away debt-free is not an easy feat.
A 529 plan, also known as a Qualified Tuition Program, is one of the most widely used and trusted tax-advantageous savings vehicles to invest in for a child.
Figuring out if a 529 plan is the right option for your family can open a Pandora’s box of questions. From considering which state-sponsored plan to pick, understanding beneficiaries and qualifying members to knowing the right contribution amounts, there are a host of decisions to consider when opening a 529 plan. It’s also important to be aware of other alternatives, like UGMA accounts, when considering the best option for you.
PENALTIES FOR UNUSED 529 FUNDS
CPA Keith Klein says that one of his clients’ primary concerns with a 529 plan is what to do with unused funds. This situation may arise if the student is granted scholarship dollars, doesn’t use all the funds as expected or even pursues a life or career path that does not require higher education.
While these accounts have alternative options, like changing the beneficiary or leveraging the dollars for private K-12, they will not work for everyone.
Historically, families have struggled to decide whether to take a non-qualified distribution from the plan. Non-qualified distributions are subject to a 10% penalty, and they must pay both the federal and state income taxes from this withdrawal.
“This situation has led to families feeling penalized for responsibly saving for college and, in some cases, even deterred families from funding 529 plans,” says Keith. “But the passing of SECURE Act 2.0 offers a few key points that change how unused funds in a 529 plan can be utilized.”
THE SECURE ACT 2.0 OFFERS OPPORTUNITY IN A ROTH IRA
With the SECURE Act 2.0, if a 529 plan is at least 15 years old, account holders can roll over up to a maximum of $35,000 into a Roth IRA. It’s important to note that the $35,000 maximum cannot be rolled over in one year and is subject to each year’s IRA contribution limits.
In 2024, it would take at least five years at an annual contribution limit of $7,000 for an IRA to reach the maximum allowable rollover amount of $35,000.
There are some additional caveats to consider when converting 529 funds into a Roth IRA. One notable stipulation is that the beneficiary on the 529 and the account holder of the Roth must be the same individual. Additionally, any contributions made to the 529 plan in the previous five years are ineligible for the rollover to the Roth IRA.
“I think it’s a triple win,” says Keith of the new rules surrounding the 529 plans. “Families can now save for college without the fear of being penalized for unused funds and the student can hopefully graduate debt free, with a jumpstart on retirement.”
Leveraging tax-advantaged dollars for higher education is just one part of your overall wealth accumulation plan and can supplement other long-term saving vehicles. Want to make sure you are leveraging the right saving vehicles? Contact us today for a complimentary consultation.
