529-to-Roth Rollover: Changes Under 2019 and 2022 SECURE Acts – Key Takeaways:
- A 529 Plan is a Tax-Advantaged Tool for Future Education Expenses.
- The SECURE Act has expanded 529 Plan usage to cover student loan repayments up to $10,000 per beneficiary.
- Starting January 1, 2024, the SECURE 2.0 Act permits rolling over limited, unused 529 Plan funds into a Roth IRA for beneficiaries meeting certain conditions.
With student loans hindering financial goals for millions of Americans, many are questioning whether college is even worth it.
Although data shows that college graduates earn more income over their lifetime, many colleges have received scrutiny for offering majors that provide little to no return on investment.
To address these concerns, Congress included college savings provisions in the 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act Then, they added more provisions when they passed the (SECURE) 2.0 Act with the Consolidated Appropriations Act of 2023.
In this blog post, we’ll go over what 529 plans are and how the SECURE Acts have enhanced their flexibility.
How 529 Plans Work
529 plans are tax-advantaged savings plans for education.
Check out The Little CPA’s LinkedIn post for a step-by-step explanation of how 529 Plans work.
These plans are sponsored by each state and allow account holders to invest in a wide range of funds to save for future education expenses. Funds within the account grow tax-free.
Certain states also allow a tax deduction for contributions made into 529 Plans.
Furthermore, the funds in the plan are used to pay for qualified education expenses, and the withdrawals are also tax-free.
{Read 3 Popular College Savings Accounts for Parents to learn more about 529 Plans and other college savings options}.
Even better, contributions to these plans are excluded from an account holder’s estate (with certain exceptions), providing estate tax benefits as well .
The tax benefits of a 529 Plan are tough to beat!
529 Plan Changes Under the SECURE Acts
Before either SECURE Act, 529 Plan account holders had strict limitations on how funds could be used.
Here are a few things that changed under the SECURE Acts –
Student Loans
Old Law: Under IRS Code Section 529(e)(3), 529 Plan savings could be used to pay for qualified education expenses. Those expenses included tuition, fees, books, qualified room and board (for students enrolled at least half time), computers and peripheral equipment at an eligible educational institution.
SECURE Act: The definition of qualified education expenses was expanded to include qualified student loan payments under IRS Code Section 529(c)(9). Now, account holders can pay up to $10,000 of student loans per beneficiary with the funds in the account.
This new flexibility allows account holders to assist their children or qualified family members in paying back their loans and continue the tax-advantages of the 529 plan.
However, it is important to note that not all states permit 529 withdrawals for student loans. Certain states assess penalties if 529 plan funds are withdrawn for student loans. Confirm your state’s conformity with your tax professional.
K-12 Expenses and Apprenticeship Programs
Old Law: 529 Plan funds could only be spent on qualified higher education expenses. The definition of qualified higher education expenses only included colleges, universities and similar post secondary education institutions.
SECURE Act: Now, up to $10,000 of 529 Plan funds can be spent each year towards qualified education expenses for grades K-12 at public, private or religious schools.These expenses include books, tuition and more.
Under IRS Code Section 529(c)(8), account holders can also spend 529 Plan funds on apprenticeship programs. The apprenticeship must be registered with the Secretary of Labor’s National Apprenticeships Act in order to use a 529 plan withdrawal.
Disabilities
Old Law: Aside from IRS Code Section 529(e)(3)(A)(ii) which permits withdrawals for services for students with special needs, 529 Plan rules had minimal accommodations for persons living with disabilities.
SECURE Act: Until January 1, 2026, qualified tuition programs allow limited funds to be rolled over to an Achieving a Better Life Experience (ABLE) account. Funds can be rolled from the designated beneficiary’s 529 savings plan, or from that of a family member, without being subject to income tax. Rolled over funds are subject to ABLE contribution limits.
Roth IRA Rollover
Old Law: Any unused 529 Plan funds could only be spent on qualified education expenses. To do this, an account holder would either have to transfer unused funds to a qualifying member of the family or withdraw the funds for non qualifying expenses and be subject to penalties.
The law does allow for flexibility around scholarships. 529 Plan funds can be withdrawn up to the amount of scholarship received. Although account holders will be subject to federal income tax on the investment earnings included in the withdrawn amount, the withdrawal will not be subject to penalties.
Example:
So, let’s say you contributed $50,000 to your daughter’s 529 Plan.
Over 18 years, it incurred investment earnings of $15,000. During her senior year of high school, your daughter earns a $10,000 scholarship to college.
You can withdraw up to $10,000 of her 529 Plan and spend it on non qualified education expenses (i.e. a car down payment) without incurring a 10% penalty.
You will have to pay tax on the applicable amount of the $15,000 of investment earnings included in the $10,000 withdrawal.
SECURE 2.0: As of January 1, 2024, unused 529 Plans can be rolled over into a Roth IRA on behalf of the account beneficiary, so long as the following apply –
- The beneficiary has earned income (i.e. has a job in which they receive wages).
- The 529 account has been in existence for at least 15 years.
- The amount being rolled over has been in the account for at least 5 years.
- The annual contribution to the IRA does not exceed the annual limitation under IRS Code Section 408A(c)(2). For 2024, this is $7,000 for individuals under age 50.
Final Considerations for 529-to-Roth Rollover: Changes Under 2019 and 2022 SECURE Acts
Although the appeal of 529 Plans have now increased thanks to the SECURE Acts, it is wise to consider all factors before choosing to move your investments into a 529 Plan.
For instance, rolling funds from a 529 Plan into an ABLE account might allow for more flexibility in how the funds are spent, but keep in mind Medicaid reimbursements. Medicaid has rights to any funds that remain upon the ABLE beneficiary’s death, as reimbursement for services performed since the account was set up. On the contrary, Medicaid does not have rights to 529 Plans.
Also, consider other laws in place such as the FAFSA Simplification Act. Under the Act, 529 Plans in which Grandparents are the account holders will no longer be included in the student’s expected contribution towards financial aid. Consider whether it might be wiser to have a Grandparent set up a 529 Plan instead of a parent.
Finally, keep in mind the timeframes required to be eligible for a 529 rollover into a Roth IRA. If you are determined to take advantage of this new rule, you will want to open a 529 account for your child as soon as possible to get the 15 year clock rolling.
Conclusion
Overall, the SECURE Acts have brought flexibility and opportunity for account holders of 529 plans. Be sure to discuss these Acts with a licensed financial advisor to determine which opportunities and challenges apply to your specific situation.
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