- Prior to the SECURE Act 2.0, if a 529 plan beneficiary did not use all of the funds for qualified education expenses (for example, the beneficiary graduated without using all of the funds in the 529), the options for withdrawal were not particularly attractive.
- However, under the new law, those “excess’ funds can be transferred to a Roth IRA for the 529 beneficiary, subject to certain limitations.
- As a result, contributions can now be made to 529 plans with the knowledge that, if not all of the funds are used for the education of the beneficiary, the excess funds can be transferred to a Roth IRA for that beneficiary (and the other options, such as transferring the money to a 529 for a different beneficiary remain available).
The President signed the Consolidated Appropriations Act, which included SECURE Act 2.0, on December 29, 2022.
SECURE Act 2.0 has over 90 provisions, some major and some minor; some mandatory and some optional; some retroactively effective and some that won’t be effective for years to come. One difference between the SECURE Act 2.0 and previous retirement plan laws is that many of 2.0’s provisions are optional…that is, plan sponsors are not required to adopt the provisions, but can if they decide that the change will help their plans and participants. This series discusses the provisions that are likely to be the most impactful, either as options or as required changes.
This article discusses one of the optional provisions that is available beginning next year, 2024. While most of my posts are about retirement plans and related issues, this is more of a financial planning matter, but it does include a retirement aspect, that is, a Roth IRA.
The Senate Finance summary of the provision says:
Section 126 [of the Act], Special rules for certain distributions from long-term qualified tuition programs to Roth IRAs. 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.
In discussing this provision with staff of the Senate Finance and HELP Committees, it was clear that the purpose of the provision was to encourage people to save for their beneficiaries’ education and it was not intended to be a financial planning tool. In other words, the Senators had heard that some people were reluctant to fund or fully fund 529 plans for fear of overfunding the accounts. As a result, this provision was included in SECURE 2.0 to allay those fears. But the Congressional representatives and the staff also realized that there was a potential for abuse and, as a result, imposed limits on the use of the provision. Those limits are:
- The 529 program must have been in place for at least 15 years. This is to prevent setting up a 529 program and funding it for the purpose of transferring the money to a Roth IRA.
- The transfer to a Roth IRA cannot exceed the amounts contributed, plus earnings, that were in the 529 account 5 years before the transfer. This is to prevent backend funding of an existing 529 account for the purpose of transferring the “new” money to a Roth IRA.
- The aggregate amount transferred to the Roth IRA cannot exceed $35,000. Obviously, this is to limit the total amount that can be transferred even if the 5-year and 15-year conditions are satisfied.
- The amount transferred in any year to a Roth IRA for a beneficiary must be combined with the Roth IRA contributions made by the beneficiary. In other words, the Roth IRA limits apply to any amounts contributed to a Roth IRA for that beneficiary—including amounts rolled over from a 529 plan. This provision does not have the effect of increasing the annual limits for that beneficiary.
Because of these limitations, the Congressional staffers and the members of the Congressional Committees involved in vetting the SECURE Act 2.0 believed that there was limited potential for abuse. My view is the same as theirs.
If that conclusion is correct, this provision should be view as a solution to a problem and not as a planning tool. However, that is in the eye of the beholder and advisors, accountants and taxpayers need to decide for themselves
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