As a mom of young children and a CERTIFIED FINANCIAL PLANNER™, a thought that’s always at the front of my mind is how to best set my children up for their futures, especially in regards to their education. Before my kids were walking, they all had a savings account. Personally, my husband and I selected 529 college savings accounts. A 529 plan boasts plenty of advantages: tax free growth, tax-free withdraws for qualifying educational expenses, and high contributions limits just to name a few.
The one catch is the term qualifying educational expenses. If you’re a fellow parent, you know that no two children are the same and trying to assume the educational path of a babbling toddler can be tricky. If you do decide to invest for your child in a 529 plan and your child ends up only needing part or none of the funds you’ve saved, you are left with few options on how use these funds without being subject to a 10% penalty and paying taxes on the earnings. Luckily, recent legislation under the SECURE Act 2.0 may have provided parents a backup plan for leftover 529 funds by way of a rollover into a Roth IRA. Of course, this won’t come without a hefty list of stipulations to do so.
When this rule within the SECURE Act 2.0 goes into effect in 2024, unused funds have the option to be rolled into a Roth as long as: the 529 plan has been opened at least 15 years, the Roth IRA receiving the funds is in the same name as the 529 beneficiary, and the beneficiary has earned income at least equal to the amount being transferred. The Act goes on to state that the current lifetime transfer limit is set at $35,000, the annual transfer limit is the annual Roth IRA contribution limit, and only contributions and earnings made more than five years ago can be transferred.
If that sounds like a lot of hoops to jump through, it’s probably because it is. But a few extra hoops could result in setting your child up for success far beyond their (potential) college years. Similar to a 529 plan, all growth within a Roth IRA is tax-free for qualified distributions. With a 529 rollover into a Roth IRA, the funds for one child could essentially receive tax free growth for decades.
Here’s an example: Bob and Sue have a child, Grace, in 2023. They open a 529 savings account and begin to contribute monthly. They stick to their goals and in 2041 when Grace reaches age 18 they have saved $200,000. Grace receives a scholarship to cover her first two years’ worth of tuition. Bob and Sue realize they are going to have an overfunded 529 plan. Grace had a part time job at 18 and continued it throughout her college career. Because of this, Bob and Sue are able to rollover the maximum Roth contribution amount of $6,500 each year that Grace has earned income from the overfunded 529 into a Roth IRA for Grace. Within six years, Bob and Sue have reach the maximum 529 to Roth rollover amount of $35,000 for Grace. If Grace doesn’t touch this account until she reached age 59 ½ and receives a 5% annualized return, her Roth IRA, started from funds when she was just a baby, would be worth approximately $190,000 and without ever paying taxes on the growth. This won’t fund Grace’s retirement, but definitely is a great gift started by her parents almost 60 years prior!
With that being said, does legislation mean that everyone should run to put funds into 529’s with the thought of rolling them into Roth IRAs in fifteen years? No, probably not. Is there potential value to be added under this new regulation? Absolutely. The reality is that both 529s and Roth IRAs could have a place in your child’s financial future. Navigating education funding and planning for the next generation should be handled on personalized level, not a one size fits all box. Work with a CFP® professional to learn what options work best for you and your family.
Published in the Victoria Advocate
Sara Potts is a CFP® Professional and Operations Manager with KMH Wealth Management, LLC