By Alex Aceves Madriz and Lena McQuillen, CFP®

How the SECURE Act 2.0 Impacts 529 Plans

529 plans are tax-advantaged accounts used to pay for qualified education costs. Because funding typically occurs well in advance of the beneficiary utilizing the plan, historically, there has been a fear of overfunding.  This fear leads some people to avoid funding 529 plans altogether.

However, with the passage of SECURE Act 2.0, there is now an opportunity for penalty- and tax-free rollovers to Roth IRA accounts beginning in 2024. Here are the important and strict guidelines that must be adhered to:

  1. The Roth IRA must be in the name of the 529 beneficiary – not the 529 owner (if different);
  2. The 529 plan must have been open for more than 15 years;
  3. Rollover amounts cannot include any 529 contributions (or earnings on those contributions) made in the preceding five-year period;
  4. The lifetime maximum amount that can be rolled from a 529 account into a Roth IRA is $35,000. There is currently no indexing of this number for inflation. This limit appears to be per beneficiary, meaning a parent with multiple children could potentially roll over $35,000 per child;
  5. Rollovers are still subject to the annual Roth IRA contribution limit ($6,500 in 2023). The total allowable rollover each year would be reduced by any contributions made by the beneficiary into their Roth or Traditional IRA; and
  6. The 529 beneficiary must also have earned income at least equal to the amount being rolled over in the year of the rollover.

What is the Downside to a 529-to-Roth Conversion?

Given the annual Roth IRA contribution limit, it will take several years to take advantage of the full $35,000 529-to-Roth IRA rollover.

It is also unclear if a new 15-year waiting period is required when changing a 529 beneficiary. Further clarification from Congress or the IRS is necessary to determine if the original inception date an account was opened can be carried over to a new 529 beneficiary.

What is the Upside to a 529-to-Roth Conversion?

This opportunity is unique in that Roth IRA income phase-out rules do not apply. Although the 529 beneficiary could have income that exceeds the annual Roth IRA contribution limit, they will still qualify for the 529-to-Roth IRA rollover. This could be considered a “backdoor” Roth IRA opportunity for high-income earners. Additionally, there is also no time limit or deadline to complete the 529-to-Roth IRA rollover.

Questions & Next Steps

For clients, please contact your Investment Counselor. For those interested in learning more about Bailard, please contact Louise Model, Vice President, at (650) 571-5800 or lmodel@bailard.com.

 

Information contained herein has been obtained from sources believed to be reliable but is not guaranteed. This publication has been distributed for informational purposes only and is not a recommendation of, or an offer to sell or solicitation of an offer to buy any particular security, strategy, or investment product. Neither Bailard nor any employee of Bailard can give tax or legal advice. The contents of this piece should not be construed as, and should not be relied upon for, tax or legal advice.