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Tax-free rollovers from 529 plans to Roth IRAs allowed as of 2024

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Americans who save for school in 529 plans will soon have a option to rescue unused funds while keeping their tax advantages intact.

A $1.7 trillion government funding package has a provision that lets savers roll money from 529 plans to Roth individual retirement accounts freed from income tax or tax penalties.

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The House passed the measure Friday and the Senate did so Thursday. The bill heads to President Biden, who’s expected to sign it into law.

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The rollover measure — which takes effect in 2024 — has some limitations. Amongst the biggest: There is a $35,000 lifetime cap on transfers.

“It’s a superb provision for individuals who have [529 accounts] and the cash hasn’t been used,” said Ed Slott, a licensed public accountant and IRA expert based in Rockville Centre, Recent York.

That may occur if a beneficiary — corresponding to a baby or grandchild — doesn’t attend a university, university, vocational or private K-12 school, or other qualifying institution, for instance. Or, a student may receive scholarships that mean some 529 funds are left over.

Thousands and thousands of 529 accounts hold billions in savings

There have been nearly 15 million 529 accounts at the tip of last 12 months, holding a complete $480 billion, according to the Investment Company Institute. That is a mean of about $30,600 per account.

529 plans carry tax benefits for school savers. Namely, investment earnings on account contributions grow tax-free and are not taxable if used for qualifying education expenses like tuition, fees, books, and room and board.

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Nonetheless, that investment growth is mostly subject to income tax and a ten% tax penalty if used for an ineligible expense.

That is where rollovers to a Roth IRA can profit savers with stranded 529 money. A transfer would skirt income tax and penalties; investments would continue to grow tax-free in a Roth account, and future retirement withdrawals would even be tax-free.  

Some think it is a handout for the wealthy

Nonetheless, some critics think the rollover policy largely amounts to a tax handout to wealthier families.

“You are giving savings incentives to those that can save and abandoning those that cannot save,” said Steve Rosenthal, a senior fellow on the Urban-Brookings Tax Policy Center.

A 2012 evaluation conducted by the Government Accountability Office found the standard American with a 529 account had “rather more wealth” than someone without: $413,500 in total wealth for the median person, about 25 times the quantity of a non-accountholder.

You are giving savings incentives to those that can save and abandoning those that cannot save.

Steve Rosenthal

senior fellow on the Urban-Brookings Tax Policy Center

Further, the standard owner had a roughly $142,000 annual income versus $45,000 for other families, the GAO report said. Almost half, 47%, had incomes over $150,000.

The brand new 529-to-Roth IRA transfer provision doesn’t carry income limits.

Limitations on 529-to-IRA transfers

While the brand new tax break primarily advantages wealthier families, there are “pretty significant” limitations on the rollovers that reduce the financial profit, Jeffrey Levine, a licensed financial planner and licensed public accountant based in St. Louis, said in a tweet.

The restrictions include:

  • A $35,000 lifetime cap on transfers.
  • Rollovers are subject to the annual Roth IRA contribution limit. (The limit is $6,500 in 2023.)
  • The rollover can only be made to the beneficiary’s Roth IRA — not that of the account owner. (In other words, a 529 owned by a parent with the kid as beneficiary would have to be rolled into the kid’s IRA, not the parent’s.)
  • The 529 account will need to have been open for at the least 15 years. (It seems changing account beneficiaries may restart that 15-year clock, Levine said.)
  • Accountholders cannot roll over contributions, or earnings on those contributions, made within the last five years.

In a summary document, the Senate Finance Committee said current 529 tax rules have “led to hesitating, delaying, or declining to fund 529s to levels needed to pay for the rising costs of education.”

“Families who sacrifice and save in 529 accounts mustn’t be punished with tax and penalty years later if the beneficiary has found an alternate option to pay for his or her education,” it said.

Are 529 plans already flexible enough?

Some education savings experts think 529 accounts have adequate flexibility in order not to discourage families from using them.

For instance, owners with leftover account funds can change beneficiaries to one other qualifying member of the family — thereby helping avoid a tax penalty for non-qualified withdrawals. Other than a child or grandkid, that member of the family could be you; a spouse; a son, daughter, brother, sister, father or mother-in-law; sibling or step-sibling; first cousin or their spouse; a niece, nephew or their spouse; or aunt and uncle, amongst others.

Owners may also keep funds in an account for a beneficiary’s graduate education or the education of a future grandchild, according to Savingforcollege.com. Funds can be used to make as much as $10,000 of student loan payments.

The tax penalty may not be quite as bad as some think, according to education expert Mark Kantrowitz. For instance, taxes are assessed on the beneficiary’s income-tax rate, which is mostly lower than the parent’s tax rate by at the least 10 percentage points.

In that case, the parent “is not any worse off than they’d have been had they saved in a taxable account,” depending on their tax rates on long-term capital gains, he said.

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