by Starting this year, some of the money in 529 college savings accounts can be used for retirement if it is not needed for education.
New rules under the federal law known as Secure 2.0 allow up to $35,000 in a 529 account to be rolled over to a Roth individual retirement account for the beneficiary of the 529 account if certain conditions are met.
State-sponsored 529 accounts, named for a section of the tax code, are used to pay for education expenses, primarily college costs. Money deposited in the accounts grows tax-free and can be withdrawn tax-free to pay for eligible expenses such as tuition, housing, food and books.
The new Roth option is aimed at parents who may be reluctant to save in a 529 because they are worried about having to pay income taxes and a penalty if for some reason the funds are not needed for college and they want to withdraw the money.
“It’s parents’ number one objection to opening a 529,” said Vivian Tsai, president emeritus of the College Savings Foundation, a group that includes large financial firms that administer state college savings programs. “The barrier is really psychological.” (Ms. Tsai is also a senior director and head of relationship management for the education savings unit of TIAA, a large investment firm that manages 529 plans in seven states.)
Many families struggle to save for college, and accumulating “too much” money is usually not a problem. “The vast majority of account holders do not save enough,” Tsai said.
He estimated average annual cost attending a four-year state university was about $28,000 for the 2022-23 school year, and was nearly $58,000 at a private four-year university. However, the average 529 account balance as of mid-2023 was about $28,000, according to College Savings Plans Network, a group that represents state 529 plans and proposes the Roth rollover option.
Still, there may be circumstances where there are leftover funds: if, for example, a student decides not to attend college, chooses a more affordable school, or obtains scholarships to cover much of the cost. Knowing there is an option to roll the money into a Roth can help overcome any reluctance to open a 529, said Peg Creonte, president of government savings at Ascensus, which supports 43 education savings plans in 26 states and the District of Columbia. .
“Families are worried that their money could be trapped,” he said. “The real benefit is that it reduces a barrier.”
There was already a way to use unused 529 funds without paying taxes, simply by appointing another family member, such as a sibling, grandchild, or spouse, as the beneficiary of the education expense account. (Ms. Tsai said she had done this by transferring funds saved in her son’s account to her younger brother, whose college costs were higher.) Parents can also be named beneficiaries of the account if they wish to continue their own education.
To qualify for the Roth rollover option, the 529 account must have been open for at least 15 years and no contributions or earnings from the last five years can be carried over. Up to $35,000 total can be transferred, but transfers are limited to the maximum annual Roth contribution, which in 2024 will be $7,000 for people under 50 years of age. To reach the maximum transfer amount, the money would have to be transferred over several years.
Other rules may also apply. To contribute to a Roth, for example, a saver must have earned income, and contributions for a given tax year can’t be more than what the saver earned, said Pam Lucina, chief fiduciary officer at Northern Trust, a financial services firm. . (The Investment Company Institute, a group that represents regulated mutual funds, has asked the Internal Revenue Service to confirm that those rules apply to transfers to a Roth from a 529.) There is no tax deduction for Roth contributions, but the accounts grow tax-free and the funds are not subject to taxes upon withdrawal.
Ascensus estimates that 15 percent of its roughly 6.5 million 529 accounts would qualify for the rollover option, Creonte said, adding that the manager saw 768 rollovers into Roths in January.
But the federal government has not yet issued formal guidance on the Roth rollover option, leaving some questions unanswered. He Investment Company Institute It has also asked the Treasury Department and the IRS, for example, to clarify whether a beneficiary change for a 529 account would “reset” the 15-year holding period.
If that were the case, a beneficiary change could complicate Roth rollovers. For example, a parent who wanted to become the beneficiary of the account and roll the money into their own Roth IRA would have to wait much longer to do so.
The Network of Savings Plans for the University sent a letter to the federal government in September stating that it does not believe a beneficiary change or other administrative changes should reset the 15-year clock and asking for confirmation of that policy.
But at least one 529 plan, the one in Pennsylvania, published an advert on its website, saying that the Treasury Department may ultimately disagree with the College Savings Plan Network’s interpretation and that it “should not be taken as legal or tax advice.”
“I would be cautious about changing beneficiaries if you think you can do a Roth transfer,” said Chris Lynch, president of TIAA’s tuition finance program.
Since unused funds may simply remain in the 529, it may make sense to wait until more details become clear. “There’s no need for people to rush,” said Rob Williams, managing director of financial planning at Charles Schwab.
But there is a deadline — this year’s federal tax filing deadline — if a saver wants to transfer funds to a Roth from a 529 and have the contribution count for the 2023 tax year, according to the Investment Company Institute. A large 529 plan, Virginia’s, also refers to the deadline for your website.
Another drawback is that some states offer a state tax deduction for residents who contribute to a 529 account. Those states may require repayment of state tax savings if 529 funds are rolled over to a Roth account. It is best to consult with a tax professional to see how a transfer may affect your finances.
Here are some questions and answers about 529 accounts and Roth rollovers:
Do transfers to Roth from a 529 count toward the maximum annual IRA contribution?
Yes. Contributions, including rollovers, cannot exceed the maximum allowable IRA limit each year.
What can I use 529 funds for besides college costs?
Funds saved in a 529 can be used to pay for tuition from kindergarten through high school, as well as for apprenticeships. Additionally, up to $10,000 from a 529 can be used to pay off student loans.
What happens if I spend money from my 529 account on non-qualified expenses?
If you use the funds for nonqualified purposes, you generally must pay ordinary income tax as well as a 10 percent tax penalty on the amount withdrawn, but only on the portion of the withdrawal attributable to earnings, Schwab’s Williams said. .
