The 529 Plan Rollover to a Roth IRA – Is it Worth it?
Episode 227 – The initial promise and excitement of a provision created by SECURE 2.0, to allow 529 Plan account balances to be rolled over to a Roth IRA, has ended in disappointment, but it may still work for you.
Transcript of Podcast Episode 227
Hello this is Bill Rainaldi, with another edition of Security Mutual’s SML Planning Minute. In today’s episode, The 529 Plan Rollover to a Roth IRA – Is it Worth it?
On December 29, 2022, President Joe Biden signed into law the Consolidated Appropriations Act, 2023. For Americans trying to save enough for retirement, an important section of that law was the portion often dubbed “the SECURE Act 2.0”, or more appropriately, “the Setting Every Community Up for Retirement Enhancement 2.0 Act of 2022” (“SECURE 2.0”). SECURE 2.0 built upon the original SECURE Act, or Setting Every Community Up for Retirement Enhancement Act of 2019, that was signed into law by President Donald Trump on December 20, 2019.
One particular provision of SECURE 2.0 initially garnered a great deal of attention. That provision allowed for tax-free rollovers of unused 529 Plan balances to a Roth IRA. 529 Plans are very attractive college funding vehicles because it allows for tax-free growth of the investments in the plan, as well as the tax-free and penalty-free withdrawal of plan balances, if used for qualified higher education expenses such as tuition, fees, books, supplies and computers. However, if any funds remained in the account because the child did not need all of the money in the plan to fund higher education, or the child failed to even go to college, the choices were either to name a new beneficiary, such as another family member, or withdraw the funds. Withdrawal of the funds, however, would be subject to income tax on the investment growth and a 10% penalty.
SECURE 2.0 provided some initial excitement with the rollover provision. After detailed analysis, however, that provision has disappointed many because of all the restrictions placed on its use. So, if you were thinking this might be a great provision for you to take advantage of, think again. We’ll briefly summarize some of those restrictions.
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This provision is not effective until 2024, so those who have 529 Plan balances will need to wait another year.
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The 529 Plan must have been in existence for at least 15 years, so newer plans are not eligible.
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The rollover can only go to the 529 Plan beneficiary’s Roth IRA, NOT the account owner’s Roth IRA. This is one of the most disappointing provisions.
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Contributions to the 529 Plan made during the last 5 years prior to the rollover are not eligible for the rollover.
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The rollover maximum is limited to $35,000, lifetime, per beneficiary.
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Even though the maximum limit is $35,000, it can’t all be rolled over in one year. Rather, the law limits the amount that can be rolled over to whatever the limit is for IRA contributions in that year. For example, the current IRA contribution limit for 2023 is $6,500 or $7,500 for those over age 50. Using those numbers, that means it would take at least 5 to 6 years to complete the maximum rollover.
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If the rollover is made, that may limit the beneficiary’s ability to make further contributions to a Roth IRA that year.
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In order to contribute to a Roth IRA, the beneficiary must have earnings, so unemployed children cannot do the rollover. Also, the ability to contribute to a Roth IRA is limited by the amount of income earned that year, so highly successful children who were beneficiaries of the 529 Plan may be barred from the rollover if they earn too much.
While this provision created a lot of excitement when it was enacted, that euphoria has died down because of the restrictions. Also, critics believe that this is just another method for the wealthy to move money to the next generation on a tax-favorable basis. Congress, however, may yet listen to the complaints and comments and fine-tune the program to make it more attractive in the future, so stay tuned.
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