Have your 529 plan funds been gathering dust, untouched and unused? Has your child’s educational trajectory taken an unexpected turn, and there are no longer plans to attend college? Read on as we bring you news that could provide some relief.

The United States Congress introduced an innovative tax strategy through the Secure 2.0 Act, capturing the attention of financial experts and tax professionals. This new strategy offers a unique opportunity for 529 plan account holders to roll over unused funds, up to a lifetime limit of $35,000, into the beneficiary’s Roth IRA without incurring any tax penalties. This inventive approach included in the legislation, passed in December 2022, is finally set to come to fruition in 2024.

Understanding the Basics:

Before we delve into the benefits of this new tax strategy, let’s first understand the key players involved: the 529 plan and the Roth IRA.

The 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. These plans, sponsored by states, state agencies, or educational institutions, allow for tax-free withdrawals when the funds are used for qualified education expenses.

On the other hand, the Roth IRA is a retirement savings account that offers tax-free growth and tax-free withdrawals, provided certain conditions are met. Contributions to a Roth IRA are made with after-tax dollars, making it an attractive option for long-term investment and wealth building.

The Secure 2.0 Act’s Twist:

Under the Secure 2.0 Act, account holders of 529 plans now have the option to roll over unused funds, up to a lifetime limit of $35,000, into the beneficiary’s Roth IRA without incurring any tax penalties, unlocking new potential for financial planning. However, this provision comes with specific details and considerations that warrant careful attention.

Details of the Provision:

1. 529 Plan Existence: The 529 plan must have been in existence for a minimum of 15 years. It’s still unclear as of now whether changing beneficiaries restarts the 15-year clock.
2. Rollover Limits: Rollovers are limited to the annual Roth contribution limit. In 2024, this limit increases to $7,000. Rolling over the entire $35,000 lifetime limit would take five years under current contribution limits. Additionally, the beneficiary must have earned income at least equal to the rollover amount.
3. Ineligibility of Recent Contributions: Contributions made in the last five years, including associated earnings, are ineligible for tax-free rollovers.
4. Impact of IRA Contributions: If the beneficiary makes any IRA contributions in a given year, the eligible 529 to Roth IRA rollover amount is reduced by the size of that contribution.
5. Ownership Alignment: The beneficiary of the 529 must also be the Roth IRA owner.
6. Direct Rollover Requirement: The rollover must be direct, such as plan-to-plan or trustee-to-trustee. Taking a distribution (e.g., a check) from a 529 and sending it to a Roth IRA is not permitted.

Now, let’s explore a hypothetical scenario. Meet Rob, a 23-year-old and the only child in his family. Rob’s parents set up a 529 account for him when he was born with the intention of supporting his college education. However, five years ago, Rob decided to pursue a career as a firefighter. Despite initial hesitation from his parents, they eventually accepted his career choice and stopped contributing to the 529 plan.

Currently, Rob’s parents find themselves with $35,000 in 529 plan assets, unsure of how to proceed without incurring income tax and a 10% penalty on the associated earnings from a nonqualified distribution. Enter Secure 2.0…with this new provision, Rob’s parents can convert the excess assets, up to a lifetime limit of $35,000, into his Roth IRA, completely tax-free. This strategic move enables them to help Rob save for retirement while avoiding potential penalties and taxes associated with nonqualified distributions.

Keep in mind that due to annual contribution limits, this strategy may take multiple years in order to fully transfer the remaining 529 plan assets. Nonetheless, Secure 2.0 provides a valuable opportunity for families like Rob’s to navigate changing educational and career plans effectively.

While these provisions introduce new possibilities for optimizing educational savings and retirement planning, it’s crucial to approach them with a thorough understanding of the nuances involved. Families should consider consulting with financial advisors to ensure that this strategy aligns with their specific goals and circumstances. If done thoughtfully, taking advantage of this new provision can be a strategic move for those with unused 529 assets, unlocking the full potential of their financial future.