Can I Roll a 529 Plan Into a Roth IRA?
If you have been saving for college using a 529 plan, changing its beneficiary could lower fees and save on taxes and penalties.
Starting in 2024, a new federal law allows beneficiaries of 529 plans that have become inactive to transfer the funds into a Roth IRA without incurring taxes and penalties – this rule is known as Section 126. Read more here!
What Is a 529 Plan?
A 529 plan provides a tax-advantaged means to save for education expenses. State income tax deductions apply in 35 states and D.C.; investments typically reside in diversified mutual funds; contributions can be made directly into an account owner’s 529 account with funds designated to an education-cost beneficiary of choice – who may change at any point!
Your account can be used to pay for eligible elementary, secondary and university education costs; graduate school tuition fees and some vocational training expenses may also qualify as qualified expenses. Withdrawals that do not meet qualifying criteria may incur federal and state income taxes as well as a 10% penalty tax.
If a beneficiary decides not to attend college or decides against it altogether, their 529 savings plan money can still be utilized; however, certain tax considerations such as generation-skipping transfer tax and superfunding need to be reviewed with an expert first.
Why Do I Need a 529 Plan?
Many families utilize 529 plans as an effective way of saving for the higher education costs of their children. By contributing funds directly towards qualified educational expenses like tuition fees, books, supplies, computers and so forth, 529 accounts allow families to bypass paying tax on withdrawals used towards tuition payments or fees, books supplies and computers.
However, if their beneficiary decides not to attend college or a qualifying vocational school as planned, the account owner is still responsible for income tax on earnings as well as potentially incurring a 10% federal penalty tax. Under Secure Act 2.0’s new rules, savers now have another option — rolling over 529 assets into a Roth IRA without incurring the 10% federal tax penalty tax.
Before taking advantage of this new rule, it would still be prudent to consult a financial planner. This is particularly pertinent if you reside in one of the 30 states offering state tax deductions or credits for contributing to 529 plans.
What Are the Benefits of a 529 Plan?
A 529 plan offers many advantages when it comes to saving for college expenses, with money invested across numerous investment vehicles such as mutual funds and exchange-traded funds (ETFs).
As soon as a student is ready for college, the account holder can withdraw funds tax-free to cover tuition expenses. Furthermore, any earnings in the account are also tax-free for even further peace of mind.
However, there are some downsides to consider. First of all, if the funds are withdrawn for non-qualified expenses – like buying a house or paying medical bills – such as buying them would incur a 10% penalty and recapture taxes (state-specific income tax deductions upon withdrawal) may apply as well.
An additional consideration when withdrawing money from a 529 is how its withdrawal may impact financial aid eligibility. When applying to college, assets in their financial aid package will be evaluated, so having substantial amounts in a 529 account can diminish their federal aid eligibility.
Can I Roll My 529 Plan into a Roth IRA?
Before recently, saving in a 529 plan and not using its funds for educational expenses required paying income tax plus an additional 10% penalty. Now however, thanks to a new federal law you may roll those unused college funds over into a Roth IRA with some limitations and restrictions attached.
Starting in 2024, the SECURE 2.0 Act allows you to transfer up to $35,000 from a 529 plan into a Roth IRA (or beneficiary’s IRA) without incurring taxes or penalties – however you cannot roll over contributions or earnings made within 15 years.
And of course, once the money from a 529 account has been transferred into a Roth IRA account, it must be invested wisely. You have various investment options available to you such as mutual funds, exchange-traded funds or target date funds or you could work with an advisor/robo-advisor; just ensure you fully understand their rules and make wise choices when investing.
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