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Secure Act 2.0: Now You Can Rollover a 529 to Roth IRA

By January 18, 2023Videos

 

So, in the last couple of videos we’ve talked about the Secure Act 2.0. Today, we’re going to talk about an intergenerational gift from Washington DC that’s buried into this act and it’s the 529 to Roth sleight of hand.

Effective 2024, these new rules, which are slightly complicated, suggest that if you have kiddos and you don’t have a 529, get one and put a dollar in and you’ll see why. Because now $35,000 of unused funds in a 529 can now be rolled over into a Roth IRA for the beneficiary. In the past, the concern has been what do we do if we overfund? Will there be a withdrawal penalty? That concern has now flipped to, “Oh, wouldn’t it be nice to have too much money, up to $35,000, and be able to roll it into a Roth IRA for the kid?”

Now, there’s a lot of moving parts to this and this is why you want to work with an advisor to make sure nothing falls to the cracks. One of the rules is called the 15-year rule, well, I call it the 15-year rule. Eessentially the account must be in existent for 15 years for you to be able to take advantage of this. So, open the account now if you don’t have it yet.

The second rule is the five year rule, which means funds must be in the account for at least five years before they can be transferred to a Roth IRA. What have we done here? We have defined a framework now for getting a 529 for each kid funded at least one to two years prior to them going to college. Now, what if it takes longer? Who cares? There’s no rule that says the money can’t just sit in a 529 and it can grow. If it’s a well selected 529, it can grow in the 529 until it hits the five year rule, the 15-year rule, as long as we don’t go over that $35,000 lifetime maximum.

Actually, what I tell people is even that may not be a big deal. Let’s say you’ve got $40,000 in there. You can do the rollover, change the beneficiary for the remainder, make it for the next generation. There’s all sorts you can do with beneficiary changes. However, the rules aren’t out. So, if you’ve got a 529 right now, you want to be very, very thoughtful about changing beneficiaries because it may start the clock when the IRS comes out with these new rules – when they finally determine how they’re going to apply this new law.

Long story short, this solves the problem of overfunding of 529. In fact, it goes beyond solving it to creating something that may be even better. A perpetual account that at some point can be turned into a Roth IRA when convenient for tax free withdrawals.

It’s too bad that the limit is $35,000, but even that limit, when we start talking about multiple beneficiaries, we start talking about multiple generations, may not be that great a constraint. It would be nice if it was $350,000, but we’ll take what the IRS gives us and certainly it beats a penalty on excess contributions once their college is complete.

For a quick recap, previously, let’s say you had $20,000 after your child had finished her education and there was no alternative beneficiary to assign that money to, you would take the money out of the 529. You would have to pay ordinary income tax on all of the gains that have accrued on that money. And you would also be subject to a 10% penalty over and above that.

So, talk to me if you need more information. If you’re one of our clients, we’re probably going to tell you at least put a dollar in a 529 right now if you got kids or even grandkids that you want to possibly benefit with this type of account.

We wish you the best of investing success.

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Next post: Secure Act 2.0 Extends IRA Required Minimum Distributions