Enhancements to 529 College Savings Plan

The 529 College Savings Plan is designed for a beneficiary to utilize the tax-free funds to cover a multitude of college expenses, including tuition, room and board, as well as mandatory fees. While this college savings vehicle might be known for its focus on education planning, the Secure Act 2.0 enhances the use of 529 accounts and helps alleviate a few common concerns we regularly hear from our clients. 

529 Account Pitfalls 

A 529 College Savings account is a great way for families to save in a tax-efficient manner for their children’s future higher education costs. While 529 accounts definitely have great benefits, we are also aware of a few pitfalls. Some families are concerned that their child might not use the entirety of the funds in their 529 account and in turn, will be subject to taxes and a penalty if the funds aren’t used for their education. As a result of such concern, some might be reluctant to use a 529 college savings account to meet future educational expenses. There are a few ways to sidestep the penalty for unused 529 funds. If you have multiple children that you are funding college for, you can always roll unused 529 funds down to the younger sibling tax and penalty-free. Knowing that these funds can be transferred to other siblings removes the worry of unused or trapped funds in a 529 account. If your child receives a scholarship, there are ways to remove funds from the 529 without taxes or penalties as well. A unique change in the Secure Act 2.0 has given one more alternative to consider. 

Secure Act 2.0  

Effective January 1st, 2024, qualified, leftover 529 account funds may be transferred to a Roth IRA, free of any tax, penalty, and applicable income limits. This gives the beneficiary the ability to transfer up to $35,000 over the course of their lifetime to their Roth IRA. If transferring unused 529 funds to a sibling did not resolve your 529 funding problem, transferring these funds to your child’s Roth IRA proves to be an ample solution. 

Naturally, a few requirements must be met to qualify for this tax-free transfer to a Roth IRA. The 529 account must have been maintained for a minimum of 15 years, with the same owner, and same designated beneficiary. Additionally, the beneficiary must have earned income up to the amount transferred to their Roth IRA, and of course, you are limited to the current Roth IRA annual contribution limit, which in 2023 is currently $6,500. 

Let’s fast forward – your child is now 25, recently graduated with their Bachelor’s, and has entered the workplace. With a four-year degree under their belt, their 529 account still has a balance of $15,000 and was opened when they were 5 years old. Now with a steady paycheck, your recent grad is eligible for Roth IRA contributions. With $15,000 sitting in their 529 account, they can contribute $6,500 (2023 annual contribution limit) of their 529 balance into their Roth IRA. Once the current year’s annual contribution limit is met, they can move an additional $6,500 into their Roth IRA the following year, and so on until the 529 account is fully depleted.  

Give You Children Financial Flexibility 

Recently out of college and new to their professional life, using these leftover 529 funds to contribute to a Roth IRA is an opportunity that will continue to compound through retirement. Early in their profession, your kid's income will likely be low, qualifying them to make Roth IRA contributions, whereas later in their career their income will likely bump them to a higher tax bracket, potentially phasing them out from making Roth IRA contributions. With these Roth IRA contributions funded directly from a 529 account instead of their paycheck, your children will have more available income to contribute to their 401(k), save for a home purchase, or even establish a rainy-day fund. Your children would be able to access the contributions from their 529 in their Roth IRA immediately for items like a downpayment on their house, but the five-year timeline still applies for accessing the gains in their accounts. 

The Bottom Line 

This is a drastic change to the world of 529 College Savings Plans. This gives parents and family members a more worthwhile reason to save for higher education while mitigating the worry of their child not going to college. Though there are requirements that must be met, this is a huge step in the right direction to motivate families to take advantage of 529 accounts.  

Ashlyn Prom