SECURE 2.0 Act: 529 to Roth IRA rollover

Opening a college fund for a child is often sentimental. Parents starting a 529 college savings plan are imagining a bright future for their beneficiaries. Will the child become a Nobel prize winning biochemist? Will they cure cancer? Will they go to Harvard? Princeton?

While 529 account holders diligently stow funds away for a child’s education with good intentions, sometimes fate has different plans. What happens if the beneficiary pursues an alternative career or goes to a fiscally friendly school?

Currently, money from a 529 plan may only be used for qualified education expenses for elementary, secondary, university, community college, and vocational schooling. It offers a tax-advantaged way to save, with Federal and state-based tax breaks. But a non-qualified withdrawal of cash may result in income taxes, and a 10% federal penalty tax may apply. So, if the beneficiary doesn’t have to pay for education or their total cost of education is less than the balance in the 529 plan, that carefully saved money might become trapped inside the 529.

Soon, there will be a new option for unused funds in a 529, thanks to the SECURE 2.0 Act. Beginning in 2024, unused 529 funds can be rolled over into a Roth IRA retirement plan for the same beneficiary.

We’ll break it down for you. Let’s start with the basics.

What is a 529 College Savings Plan?

529 plans are qualified tuition programs and get their name from Section 529 of the federal tax code. Simplified, a 529 plan is a tax-advantaged educational savings plan. The account is funded with post-tax dollars from the account holder in the name of a designated beneficiary. It grows with compounding interest, tax-free. When the beneficiary is ready, they can make tax-free payments toward qualified education expenses such as tuition, fees or room and board at any eligible school in the U.S. (and some abroad). Each state has different maximum contribution limits.

What is a Roth IRA?

A Roth IRA is a retirement account funded with post-tax dollars. A Roth IRA can hold a range of investments from traditional stocks, bonds, and mutual funds to alternatives like privately-traded securities. These investments grow tax-free. Only earned income can be contributed to a Roth IRA. Eligibility for a Roth IRA depends on income limits set by the Internal Revenue Service, and contribution amounts are subject to a phaseout as the individual approaches that income limit. Annual Roth IRA contribution limits in 2023 are: $6,500 or $7,500 for people over 50. Withdrawals after age 59 ½ are tax-free, as long as the account has been open for at least five years.

Although a Roth IRA is a retirement account, some contributions can be used for a few other things, tax-free. For example, Roth IRA rules allow account holders to withdraw up to $10,000 for a first-time home purchase without an early withdrawal penalty. Note: Contributions need to have been made at least five years before they can be withdrawn for a first-time home purchase. It’s best to consult with a tax advisor before withdrawing any funds from your Roth IRA.

What is the SECURE 2.0 Act?

The original SECURE Act was passed in 2019 to address the retirement crisis. SECURE 2.0 was passed in 2022 and builds upon the initial act.

The legislation introduced several new provisions. One new provision is Section 126, which details rules for distributions from a 529 plan to a Roth IRA for the same beneficiary. Section 126 will be effective starting in 2024.

Let’s go over the details of Section 126.

The SECURE 2.0 Act: 529 to Roth IRA Rollover

Thanks to SECURE 2.0, unused funds from 529 plans can rollover to Roth IRAs to establish a nest egg for the same beneficiary. The rollover is penalty-free.

The Senate Committee on Finance summary of Section 126 reads:

“Section 126 amends the Internal Revenue Code to allow for tax and penalty free rollovers from 529 accounts to Roth IRAs, under certain conditions. Beneficiaries of 529 college savings accounts would be permitted to rollover up to $35,000 over the course of their lifetime from any 529 account in their name to their Roth IRA. These rollovers are also subject to Roth IRA annual contribution limits, and the 529 account must have been open for more than 15 years.

“Families and students have concerns about leftover funds being trapped in 529 accounts unless they take a non-qualified withdrawal and assume a penalty. This has led to hesitating, delaying, or declining to fund 529s to levels needed to pay for the rising costs of education. Section 126 eliminates this concern by providing families and students with the option to avoid the penalty, resulting in families putting more into their 529 account. Families who sacrifice and save in 529 accounts should not be punished with tax and penalty years later if the beneficiary has found an alternative way to pay for their education. They should be able to retain their savings and begin their retirement account on a positive note. Section 126 is effective with respect to distributions after December 31, 2023.”

The key takeaways here are:

• The lifetime 529 rollover limit is $35,000.
• The Roth IRA must be for the same beneficiary named in the 529 plan.
• The 529 account must be open for more than 15 years before it is eligible to roll into a Roth IRA.
• 529 contributions made within the prior five years cannot be rolled over.
• Rollovers are subject to annual Roth IRA contribution limits.

This option allows 529 account holders to continue providing a bright future for their beneficiaries —giving new grads a head start on their retirement savings with compound interest on their side. Roth IRAs offer flexibility, such as the ability to put money towards a home and ensures that the gift of a 529 won’t go to waste.

Interested in rolling over 529 funds into a Roth IRA? Reach out to your financial advisor to initiate the rollover, starting in 2024.

Need to start an IRA? Millennium Trust offers self-directed IRAs.

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Millennium Trust Company performs the duties of a directed custodian, and as such does not offer or sell investments or provide investment, legal, or tax advice.