Conserving savings for college tuition can be one of the most critical financial goals, yet families may find themselves with extra funds in their 529 accounts that remain unspent.
Start 2024, beneficiaries can move unused assets into Roth individual retirement accounts without incurring taxes or penalties – an appealing prospect for many families.
Tax-Free Growth
A 529 plan is a tax-advantaged investment vehicle designed to help parents save for college education costs for a designated beneficiary. Distributions from this account may only be used to pay qualified educational expenses such as tuition fees, room and board or books; earnings typically remain tax-free but a 10% penalty applies if funds are taken out for non-qualified expenses.
SECURE Act 2.0 now permits an option for 529 funds that have not been utilized to be transferred over to Roth IRA accounts after 15 years have passed. These regulations will apply specifically for accounts which have stayed open over that time frame.
529 plans offer another unique benefit – changing beneficiaries down through generations – but due to tax considerations it is recommended that this be done under professional advice. Also holding assets directly in the name of beneficiaries may negatively impact financial aid more so than holding assets in parent’s name.
Tax-Free Withdrawals
529 plans offer many attractive features, one being their potential to grow tax-free over time if they receive state tax deductions, which is the case in 35 states.
But if you use funds from your plan for non-qualified expenses – like purchasing a new car or wedding costs – taxes will apply on any earnings-only portion of the withdrawal. That is why it is wise to seek advice from an advisor prior to withdrawing money from either a 529 plan or Roth IRA.
Beginning in 2024, due to Secure Act 2.0 legislation passed late 2022, any unneeded money from a 529 account can now be moved directly into a beneficiary’s Roth IRA without penalty – an improvement over previous law which subjected any withdrawal subject to taxes and a 10% penalty (only earnings were taxed; original contributions weren’t taxed). This change makes saving through 529 plans even more appealing.
Taxes on Distributions
Up until now, there have been few options if a 529 fund wasn’t being used for college education. Withdraw the money and pay income tax or switch it over to another beneficiary–though this involves complex rules. Seek professional advice when facing this scenario.
The new law that goes into effect in 2024 makes it simpler for Americans to roll over unused 529 funds into Roth IRAs; however, it is important to understand its restrictions, such as no contributions or earnings from 529 plans that have been opened more than 15 years prior.
Limits should not be an issue for most, though some individuals may be affected. Furthermore, it’s unclear whether or not the 15-year rule resets when beneficiaries change; financial advisors can offer insight. Nonetheless, this change may make 529 plans more appealing to certain people.
Rollover Options
Parents left with college savings funds after their child graduates or opts out will soon have another rollover option available to them as part of the SECURE 2.0 Act, set to go into effect in 2020. Money left over from 529 plans can now be moved directly into Roth IRA accounts without incurring taxes or penalties, giving these parents flexibility when dealing with unclaimed college savings funds.
Investment earnings on the funds rolled-over will continue to accrue tax-free and withdrawals made for retirement purposes will not incur income taxes. There are some restrictions in moving these accounts: the Roth IRA must be under the beneficiary’s name and cannot contain more than $35,000; any 529 contributions and earnings made over the past five years cannot be transferred either.
One final point: It is essential to keep in mind that rolling over an investment account involves selling assets and purchasing new ones – an action which may alter market timing, which in turn may impact long-term performance.
