Sometimes you dream something up and the tax code changes to make it true. What – you don’t also dream about the tax code? I’ve often wished that there was a rollover allowance to a Roth IRA from a 529 Savings Plan and its finally law!
Compared to the first pass of the Secure Act, the second version didn’t include many provisions that we felt the need to hurry up to share with our clients. There were a few interesting pieces that we thought we could use as financial planning tools – the one that is probably most notable is that you can use leftover 529 monies to fund a Roth IRA beginning in 2024.
When discussing 529 College Savings Plans with clients, one of the most frequent push backs we hear is the fear of overfunding. Clients would often wonder what they could do if they put too much money into the plan and the student was the recipient of a scholarship or ended up not going to school. This was a valid concern, because before Secure Act 2.0, the only way to get funds out for the intended beneficiary would be to take a taxable and penalty accessed distribution.
Secure Act 2.0 provided relief for this concern with the allowable rollover to Roth IRAs provision. This rule has a lot of nuisances, but essentially it allows for leftover 529 funds to be rolled into a Roth with up to a $35,000 lifetime limit. This provision goes into effect in 2024 and is only available for 529 Plans that have been established for 15 years. Additionally, any contributions or earnings added into the 529 Plan in the past five years are not eligible for rollover to try to discourage people from funding 529s for the sole purpose of rolling money into a Roth IRA.
There is good news for high earnings in this rule, the annual MAGI limit for making a Roth contribution does not apply to the rollover. Meaning that high wage earners with old 529 Plans would be able to get money into a Roth IRA without worrying about the limit. It’s important to remember that any rollover is limited to the yearly contribution limit, which is $6,500 for 2023 for those under age 50.
While this rule only applies to a limited number of clients, those who this does apply we would urge to take advantage of this opportunity for tax free growth. By investing $35,000 into a Roth IRA at age 25 and waiting until age 65 to retire and assuming a 6% rate of return you could except the account value to grow to approximately $383,000. This amount of money could certainly make an impact on someone’s retirement.
For more information about 529s, Secure Act 2.0, or to hear random wishing about tax law, give the Mancino-Utz Group at Baird a call.