To Inform:

How do I fund education costs for my kids and grandkids? This is one of the perennial questions that parents and grandparents face when it comes to education costs. 529 accounts have long been the answer for people looking for tax-deferred growth for education expenses (if you’re unfamiliar with 529s, be sure to check out this post by my colleague Dave Suchland). However, some parents hesitate to fully lean in to 529 accounts because of the limitations around distributions that are not used for qualified education expenses.

In response to these issues, Congress has recently passed two separate bills called the SECURE Act 1.0 and the SECURE Act 2.0. Many of the provisions in these two pieces of legislation went a long way toward resolving some of the issues around using 529s and should allow more parents to utilize this incredible education savings tool more fully by allowing the remaining balance of 529 accounts (up to $35,000) to be rolled over to a Roth IRA tax and penalty free!

The Problem with 529s

Historically, 529 accounts could only be used for post-secondary education expenses. This created a conundrum for families who were trying to plan for these expenses. Common questions around this topic include, “What if my child doesn’t go to college?” “What if my child receives financial aid and doesn’t need as much as we anticipated?” “What if we save for an expensive education, but my child ends up going to a less expensive school?”. Since there is a 10% penalty for withdrawing funds in addition to paying federal and state taxes on the growth from a 529 account for non-education expenses, many parents and grandparents were hesitant to put too much money into a 529 account for fear of overfunding it and paying penalties later. As a result, Congress responded with the SECURE Act 1.0.

The First Fix Under the Secure Act 1.0

The SECURE Act 1.0, passed back in 2019, broadened the uses of 529 accounts. First it allowed them to be used for K-12 education and apprenticeship programs in addition to college education. Furthermore, 529s could be used to repay up to $10,000 of student loan debt. These provisions helped to lessen the fear that there wouldn’t be enough expenses to use up 529 account balances. However, there remained the problem about what to do if there was money left over after a beneficiary was out of school.

The Second Fix Under the SECURE Act 2.0

The SECURE Act 2.0, passed in December 2022, went a step farther to resolving this issue about what to do with a remaining balance in a 529 account. Starting in 2024, 529s can now be rolled over to a beneficiary’s Roth IRA. However, there are a few key caveats to be aware of:

• A 529 account must be open for at least 15 years before becoming eligible for a Roth IRA rollover.
• The annual rollover amount is capped by the inflation-adjusted Roth IRA contribution limit. For 2023, the Roth IRA contribution limit is $6,500 for people under age 50, so the maximum that could be rolled over is $6,500 per year. The beneficiary would not be able to contribute any additional money to the Roth IRA or traditional IRA in that same year once this limit has been reached.
• The beneficiary of the Roth IRA must have earned income equal to or exceeding the amount rolled in from a 529 account. In other words, no rollovers are allowed until the beneficiary has some earned income.
• There is a lifetime limit of $35,000 for rollovers from a 529 to a Roth IRA and this amount is not indexed to inflation.
• Contributions made within the last 5 years to a 529 aren’t eligible for a rollover to a Roth IRA.

This ability to rollover to a Roth IRA is a big deal! It goes a long way to solving the issue of what to do with leftover funds in 529 accounts and removes a key barrier that holds many parents and grandparents from contributing more to 529 accounts. Now these funds can be rolled over tax-free and penalty-free to a Roth IRA and subsequently go on to grow tax-free for the rest of the beneficiary’s lifetime. This opportunity potentially gives beneficiaries a big head-start toward their own retirement savings once the expenses of schooling are behind them.

A Few Key Unresolved Questions

The SECURE Act 2.0 legislation left a few key questions open for interpretation:

• First, is more than one Roth IRA rollover permitted from the same 529 account? The beneficiary of a 529 account can be changed at any time, so a 529 account owner could potentially do one $35,000 rollover to the first beneficiary and then change the beneficiary to a different person and then do another $35,000 rollover.
• Second, if more than one beneficiary can receive Roth IRA rollovers, can an account owner do this immediately, or would a new 15-year limit be imposed before the new beneficiary could receive Roth IRA rollovers?

We’ll need to wait for guidance from the IRS about whether more than one Roth IRA rollover is allowed and whether the 15-year waiting period is renewed each time the beneficiary is changed.

Conclusion

Funding education expenses for children and grandchildren will continue to be a challenge for many families. Fortunately, for those can save for these expenses, the SECURE Act 1.0 and 2.0 resolved many of the key drawbacks for using a 529 account for this purpose. Notably, the most recent change which allows rollovers to a Roth IRA largely solves the problem of overfunding a 529. More details will emerge over time about how and when this provision can be used, but in the meantime, 529 accounts just became a lot more attractive to solving the education funding riddle.

If you have questions about how to establish, fund or utilize a 529 plan please contact your Joseph Group advisor. We love to help our clients think about planning for specific goals and how to accomplishing goals just like this.

Written by Jake Martin, Client Advisor