What This New Option Means for Those Who Qualify
In a recent article, I outlined the key retirement planning changes included in the bipartisan budget bill that president Biden signed in December. If you haven’t read that article yet, I encourage you to do so because the new law includes many retirement savings changes that may be relevant to your financial plan. Called the SECURE Act 2.0, it had the impact of reshaping retirement tax incentives and existing retirement account rules in ways that are likely to have consequences for some time.
The SECURE Act 2.0 contains more than one hundred provisions dealing with retirement savings, but today I want to concentrate on the fact that it enables some people to convert a 529 educational savings account into a Roth IRA beginning in 2024.
What is a 529 Account?
First, if you’re not familiar with what a 529 plan is, here’s a basic primer:
Also called a Qualified Tuition Program, it’s a tax-advantaged investment vehicle that encourages saving for college. The account must be designated to a specific beneficiary, and withdrawals are tax-free as long as they’re used for qualified education expenses. Typically, that means 529 dollars can be used for anything a student needs to attend an accredited college or university or a technical or vocational school. Qualifying expenses may be things like tuition, room and board, books and supplies, and technology. Not all expenses will qualify, with health insurance and child care among them. If 529 dollars are used for non-qualifying expenses, the withdrawals will be subject to regular income tax and also a 10% penalty.
SECURE Act 2.0 529 Plan Rollover Option
This new option is exciting and takes effect in 2024, though it will apply in fairly limited circumstances. The 529 plan must have been maintained for at least 15 years, and the Roth IRA account must be in the name of the 529 plan beneficiary. There is a $ 35,000 lifetime limit on funds that can be rolled over, and all rollovers must fall within the annual Roth IRA contribution limits.
So, the result is that some people with 529 plans in their names who are not going to utilize the dollars for educational expenses may be able to roll over to a Roth IRA – tax-free and penalty-free. Frankly, this just makes sense. Why should anyone who sacrificed and planned ahead by saving in a 529 account be penalized years later if the account beneficiary has found an alternative way to finance their education? For that reason, I think this is one of the more exciting provisions in the SECURE Act 2.0. However, it should be noted that contributions made in the last five years are not eligible for tax-free transfers to a Roth.
The Advantages of a 529 Rollover
A 529 account is an investment account, and down markets – as we’ve seen over the last year – make for great opportunities to do Roth conversions. Why? Well, you can convert assets that are down due to the market into the Roth. This means you can get more shares converted to the Roth for the same income recognition for doing the conversion. Assuming the market recovers, this bounce-back happens in the Roth – tax-free – from the point of conversion forward (so long as withdrawals don’t take place in the Roth conversion account at least five years from the first conversion).
It bears repeating: your money grows tax-free in a Roth IRA. You will not pay income tax when you make qualified withdrawals, and there is no RMD requirement either (as you would have with a traditional IRA). All things considered, you can see how this SECURE Act 2.0 provision can be truly advantageous to 529 account holders who qualify for this rollover option.
Can You Benefit from New SECURE Act 2.0 Provisions?
Whether you qualify for this new 529 rollover option or not, it’s likely that other aspects of the SECURE Act 2.0 will impact your retirement planning efforts. If you’d like to make sure you’re taking advantage of any new opportunities available to you, schedule a conversation with us today.