The Secure Act 2.0 – signed into law in December of 2022, provides a unique opportunity for a tax-free rollover into the respective 529 plan beneficiary’s Roth IRA.
529 Plans serve as a great tool to fund and save for higher education expenses through tax-deferred growth of funds contributed and tax-free withdrawals for qualified educational expenses such as tuition, room, board, books, supplies, etc. Additionally, 529 plans possess state income tax advantages in some states along with annual gift tax exclusion opportunities for the donor(s). With a historic bull-run in the market from 2010 – 2020, this resulted in many 529 plans being over-funded: leaving donors with 2 options:
- Change the beneficiary to an eligible family member to avoid penalty
- Make a non-qualified distribution to the respective beneficiary
- Results in ordinary income tax and a 10% penalty on the earnings attributable to the withdrawal
Due to this, families have been apprehensive to fund 529 plans in order to combat rising education costs. Now, the Secure Act 2.0 has added a layer of flexibility to over-funded 529 plan accounts with the addition of a tax-free rollover to the respective beneficiary’s Roth IRA.
Here is a breakdown of the new rules:
- Rollovers are subject to annual Roth IRA contribution limits ($7,000 per year as of 2024)
- Beneficiary’s must have earned income greater than or equal to the rollover amount
- Rollovers are subject to a lifetime rollover cap of $35,000 – adjusted for inflation
- Eligible 529 plan accounts for rollover must have been opened and maintained for 15+ years
- Rollover amounts cannot include amounts contributed to the plan in the preceding 5 year period
- Rollovers are NOT subject to the Roth IRA contribution income limitations
- 2024 tax year income phaseouts for Roth IRA contributions start at $146,000 for single filing taxpayers and $230,000 for married filing jointly taxpayers
The ability to rollover monies from a 529 plan account to a Roth IRA can help start or bolster a respective beneficiary’s retirement savings. A Roth IRA grows income tax free, and withdrawals are income tax free upon turning 59 ½ years old – which is extremely beneficial for long-term growth and accumulation for retirement.
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