529 plan savings is one of the best ways to save for education. The contributions go in after taxes but grow tax deferred until withdrawn. When funds are withdrawn for qualified expenses, they are tax-free.
The downside, if money is withdrawn for nonqualified expenses, it is taxed as ordinary income on the growth of the account plus a 10% penalty to the owner of the account or beneficiary. Therefore, parents are concerned about the tax consequences if the beneficiary doesn’t go to college, is the recipient of a scholarship, or financial aid and 529 plan funds are not used.
Secure 2.0 Act – In 2022 Congress passed the Secure 2.0 Act some of these concerns by introducing a special rule allowing distributions from a 529 Plan to be rolled to a Roth for the 529 Plan beneficiary without taxes or penalty. The distribution rules are complex and take effect in 2024.
The 529 plan rollover rules and limitation are summarized:
- Lifetime maximum a 529 Plan beneficiary can roll under the rule is $35,000.
- The 529 Plan account must have existed for at least 15 years before funds can be rolled to a Roth.
- No contributions or earnings on contributions from the last five years can be rolled over.
- Rollover limits are subject to annual Roth IRA contribution limits (but there is no upper income constraint) – note, beneficiary limits must have earned income based on their filing status and IRA contributions based on his/her age i.e., currently it’s $6500 if younger than 50 and $7500 if 50 or older.
– Beneficiaries may be changed to the owner, spouse, or other family member.
– There is no time limit when 529 Plans must be redeemed.
The following summary examples navigate and demonstrate rule limitations.
- Beneficiary has made direct contributions to an IRA already in the year he/she wishes to roll a part of his/her 529 Plan remaining funds.
- Beneficiary earns less than the annual Roth IRA contribution limit. Then he/she may only rollover an amount equal to his/her earned income. Note, income limit is defined by their tax filing status and taxable income.
- Beneficiaries 529 Plan may have increased due to account growth. Then any funds left in the account over the maximum $35,000 rolled over are subject to the provisions mentioned.
– Taking a tax distribution using funds to pay off up to $10,000 of qualified student loans of his/hers, siblings.
– Named him/her-self, a spouse, one of his family members as beneficiary.
–Use up to $10,000 for the first-time home purchase.
- The 529 Plan was established less than 15 years ago. Then the beneficiary must hold the 529 Plan till it is at least 15 years.
- Contributions were made to the account within the past five years.
– Note, it appears that withdrawals from the plan in the last 4/5 years are not an issue in calculating contributions made in the last five years.
–For example, if the beneficiary had $20,000 left in his/her account in 2022 of which $1000 per year was made in the past four years (2018 – 2022). Then, by 2024, $18,000 is eligible for maximum Roth rollover is limitations to current of $6500-$7500 depending on the beneficiary’s age in 2024. Of the remaining $2000 contribution $1000 would become eligible in 2025 and the remaining $1000 would become eligible in 2026.
(Karen and/or Pat welcomes your questions and comments: firstname.lastname@example.org; email@example.com.)
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual
Sources: 1. Compilation- “traditional IRAs and Roth IRAs” and Finance Senite.gov “SECURE 2.0 act of 2022. “6 ways to spend and use 529 funds by Kay Flynn, May 4, 2023. “The savings again June 6, 2023; “Blueprint Roth Conversion Rules”, Gobler & Albersladt July 23, 2023
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