new Secure Act 2.0 law allows 529 college savings accounts to be rolled over tax free into Roth IRA retirement Accts

The federal Secure Act 2.0 law now allows up to $35,000 from 529 college savings accounts to be rolled over into a Roth IRA retirement account under certain conditions. Recently, the NY Times reported that this change provides more flexibility for 529 account beneficiaries who do not need the funds for educational expenses.

Previously, 529 accounts could only be used for tuition, housing, food, and textbooks without incurring taxes or penalties. Now, suppose there is excess money in a beneficiary’s 529. In that case, it can be withdrawn and put into a tax-advantaged Roth IRA account earmarked for that beneficiary’s retirement instead.     

529 Savings Plan Background 

529 savings plans provide tax incentives for setting aside college funds, allowing money to grow tax-free and withdrawals to be tax-free when used on qualified higher education expenses. Contributions are not federally deductible but many states offer state tax deductions.

However, a major downside has been uncertainty around unused 529 savings – such as if the beneficiary gets a scholarship or doesn’t attend college. Previously, non-education withdrawals incurred taxes and penalties, deterring many families. 

The SECURE 2.0 Act, passed by Congress in December 2022, allows savers to roll over unused 529 funds into a Roth IRA without a tax penalty starting in 2024. The law has the following requirements: 

• The Roth IRA must be for the same beneficiary as the 529 plan
• The 529 account must be open for more than 15 years
• The rollover limit is $35,000 in total over a lifetime

This new rollover ability encourages more parents to open 529s since they no longer have to worry about taxes or penalties if the accounts are not fully used for college expenses. It provides an alternative retirement savings option for unused 529 funds. Vivian Tsai, chair emeritus of the College Savings Foundation, told NYT, “It is parents’ No. 1 objection to opening a 529,” stating that the fear is not based on reality since many families struggle to save for college and accumulating “too much” money is usually not a problem. “The vast majority of 529 account holders do not save enough.”

College costs continue rising, with average annual expenses of $28,000 at public 4-year universities and $58,000 at private colleges in 2022-23    

Yet not all 529 savings end up being used for college, whether because a student doesn’t attend, chooses an affordable option, or gets scholarships. In these cases, families previously had limited options besides withdrawing the excess money and incurring taxes/penalties.

Now the Secure 2.0 law allows up to $35,000 from an unused 529 account to instead be rolled over into a tax-advantaged Roth IRA retirement account for the beneficiary. This provides a new avenue for leftover 529 funds while still keeping the tax benefit.

By removing concerns about “wasting” 529 savings not used for college, the new Roth rollover rules may encourage more families to open accounts and start preparing early for their child’s post-high school needs.    

Even before the new Secure 2.0 law, families had options to reassign leftover 529 funds without tax penalties by changing the account beneficiary. If the original designated beneficiary ends up not needing the full savings amount, the excess can be transferred to another eligible family member’s higher education costs – such as a younger sibling, grandchild, spouse, or even the parents themselves if they want to pursue further schooling. This allows unused 529 money to remain in the tax-advantaged account while redirecting it to cover the continued college expenses of another relative instead of just withdrawing it for non-education purposes. 

The new law simply provides another avenue for tax-free use of excess 529 savings by allowing a limited rollover to a Roth IRA retirement account. 

How do you qualify for the 529 rollover? 

To utilize the 529 rollover to a Roth IRA, there are several eligibility rules, limitations, and requirements that must be met: 

1. The 529 account must have been open for at least 15 years
2. No contributions or earnings can be transferred from the last 5 years
3. The maximum rollover amount is $35,000 total over multiple years – In 2024, only $7,000 (current annual Roth contribution limit) can be moved over – The beneficiary would have to move smaller amounts each year to eventually hit $35,000
4. The beneficiary must have earned income and meet Roth contribution limits
5. Roth rules requiring earnings to be below max Roth contribution amounts for that tax year are likely required (IRS confirmation pending) 
6. Withdrawals from a 529 plan for anything other than qualified education expenses may be subject to income tax and a 10% penalty
7. Up to $10,000 per year can be used for K-12 tuition
8. Some states may impose a penalty or make the earnings portion of the distribution taxable on a state tax return

The main benefits of using the rollover – funds transferred grow tax free and are not taxed upon withdrawal since they end up in the Roth IRA.

So far, estimates indicate about 15% of 529 accounts may be eligible for and able to use this new retirement savings rollover option if not fully utilized for college expenses. But several considerations apply for qualification.

Treasury and IRS guidelines are still needed to answer outstanding some questions

While the Roth rollover option from 529 accounts is now federal law under Secure 2.0, formal guidance from the government on specifics is still forthcoming. This leaves certain questions unresolved.

Key details the investment community has asked the Treasury and IRS to clarify include:

• Would changing the 529 beneficiary “reset” the 15-year holding requirement to do a rollover?

If so, this could complicate families’ ability to rollover funds if they need to update beneficiaries. For example, if a parent becomes the new beneficiary to rollover excess funds to their own Roth IRA, they may have to wait much longer if the 15-year clock restarts.

The College Savings Plans Network has requested confirmation that administrative changes like beneficiary updates should NOT reset the 15-year qualification period.   

At this point some financial advisors are suggesting be cautious about changing beneficiaries if you think you may do a Roth rollover in the next few Since unused funds can simply remain in the 529, it may make sense to wait until more details are clarified. years. Rob Williams, managing director of financial planning at Charles Schwab to the NYT that “There isn’t any need for people to rush it.”   

While full guidance is still pending, there is an important deadline for utilizing the new 529-to-Roth rollover this tax year. According to investment industry sources, any transfers counted for 2023 must be completed by this year’s federal tax filing due date.

Additionally, some complications may arise for savers in states offering tax deductions on 529 contributions. Rolling over those funds to a Roth IRA could require repaying the state for those earlier tax savings. Consultation with a tax professional is advisable to understand state-specific impacts.

As people navigate this new option to repurpose unused 529 funds for retirement instead of just education, questions are arising. Some key questions and answers include: 

Do rollovers from 529s to Roth IRAs count toward the annual IRA contribution limit?

Yes, 529-to-Roth rollovers are included when calculating if the maximum annual IRA contribution amount has been reached. The total contributions and rollovers together cannot exceed the annual Roth IRA limit.

What can 529 funds be used for, besides college expenses?

529 funds now have expanded uses beyond just college costs. The savings can also pay for tuition at private K-12 schools, apprenticeships, up to $10,000 in student loan repayment, and more. The new retirement rollover option also allows redirecting unused funds to retirement savings.

What happens if I withdraw 529 funds for non-qualified expenses?

Withdrawing 529 funds for purposes besides the qualified education-related expenses will generally incur income taxes plus a 10% penalty on earnings attributed to that non-qualified withdrawal amount. So it’s important to use the savings only on approved uses to avoid losing the tax benefits.