Key Takeaways
Saving in a 529 plan is no longer a use-it-or-lose-it proposition.
As of January 1, 2024, unused funds in a 529 plan can be rolled over to a Roth IRA for the beneficiary, in most cases without penalty or tax consequences.
You now have the opportunity to simultaneously save for your children's college education and retirement, a first-of-its-kind option.
As National 529 Day draws near (May 29th), it's important to highlight several considerations. With college tuition consistently outpacing inflation, higher education represents a significant financial burden for many households. Utilizing a 529 account to save toward a child's education is one of the most effective and tax-advantaged methods. However, clients frequently inquire about the optimal contribution amount.
It's widely understood that starting to save for significant future goals sooner rather than later is beneficial. However, the decision-making process becomes intricate when children are in their early years or even middle school. Uncertainties arise regarding their interests or their inclination toward pursuing higher education after completing high school. As a result, many young parents don’t want to overfund their children’s 529 accounts, especially when they have so many other expenses to deal with. Don’t let that dissuade you from saving adequately for their higher education.
Thanks to the SECURE 2.0 Act of 2022, saving in a 529 is no longer a use-it-or-lose-it proposition. For instance, if your child never goes to college or doesn’t need the funds for tuition thanks to a scholarship, grant, or gift from a relative, as of Jan 1, 2024, you can roll a portion of unused funds from a child’s 529 plan into the child’s (beneficiary’s) Roth IRA without a tax penalty.
Restrictions And Considerations
Before initiating a rollover, make sure to discuss the following with your advisor:
1. There is a maximum amount of $35,000 as a lifetime limit which can be rolled from a 529 Plan to a Roth IRA.
2. You need to have owned the 529 plan for at least 15 years before you can roll over funds to a Roth IRA. Also, any contributions made in the last five years before distributions began (including any earnings) are not eligible to be rolled over.
3. The rollover should be done strategically, as you cannot roll over an amount greater than the annual Roth Contribution limit ($7,000 in 2024). For instance, using today’s limit it would take 5 years to roll over the entire $35,000 ($7,000 per year over 5 years).
4. The beneficiary of the 529 plan must be the owner of the Roth IRA and must have earned income equal to or greater than the amount they plan to roll over.
Finally, ensure your state allows 529 plan to Roth IRA conversions. If you and your advisor can check all the boxes above, rolling over unused 529 account funds can be a unique opportunity to help a child save early for retirement now that you’ve managed their educational expenses. Again, there's no penalty for the transfer to the Roth IRA and that's now a tax-free vehicle that grows until the beneficiary’s retirement.
For more, see our Managing Partner, Bob Dunn’s post What to Do with Leftover 529 Funds?
Start With The End In Mind
When discussing education planning with new parents, we often ask about their desire to finance their children's education. It’s not always about their income or available cash.
Parents often shape their approach to funding their children's education based on their current experiences. Whether they were fully supported through college or had to work part-time to make ends meet, these experiences will often influence their perspectives. One parent may advocate for their children to take on some financial responsibility, believing it builds character, while the other may prioritize prestigious institutions based on family tradition. When such differences arise, we advise couples to discuss their priorities and find common ground before diving into financial planning for their children's education.
Conclusion
If you or someone close to you has concerns about saving for college or what to do with excess funds in a 529 plan, reach out any time. I’m happy to assist.
BRENDEN LEESE, CFP® is an Associate Wealth Advisor at Novi Wealth Partners