It’s often a question for parents and relatives of young children: How much should we fund for college, and what if that child does not use all those funds by the conclusion of their education or decides to pursue a career via a non-qualifying education expense?
As part of the Secure 2.0 Act passed by Congress in 2022, a new ability to convert a lifetime limit of $35,000 from a 529 plan to a Roth IRA for each beneficiary has been enabled. However, the conversion is subject to a few qualifying details beginning in 2024:
- The 529 plan has to be owned by the beneficiary for at least 15 years prior to the conversion of funds into the Roth and the name on the 529 must be the same as the Roth IRA owner.
- The conversion is limited to the annual Roth IRA contribution limits, making this a multiyear strategy of conversion. The current limit of $6,500 would take close to six years to complete, subject to reporting and tracking.
- The amount of funds converted also may not exceed the aggregate amount contributed to the 529 in the five years prior to the Roth IRA beginning conversion date.
- It is unclarified at this time if contribution limits and income would be the beneficiary’s, and not the parents/relatives, to complete the above transfers.
Unlike regular Roth contributions, which have modified adjusted gross income limitations, conversions to a Roth IRA from a 529 aren’t similarly restricted at this time.1 Such a transfer would be subject to Roth IRA annual contribution limits. However, there may be instances where the 529 beneficiary is not eligible to transfer the full amount of the annual Roth IRA contribution limit from the 529 because the 529 beneficiary had no income or small income during a calendar year, made the maximum contributions to a Roth IRA or a traditional IRA during the same calendar year, or had a relatively large income.
There are currently no federal deductions available for 529 contributions. Some states offer deductions which would need to be explored individually by your tax consultant.
When could this make sense?
- If you have a child or loved one who is age 10 or younger, allowing for the 15-year minimum on the 529 to be complete.
- If you have a child with an existing 529 that has been open for at least 15 years but have no further need for qualifying education expenses and potentially earns at least the annual contribution limit.
- An adult child, no longer in school, and nearing the age limit (plan specific at various ages 28, 30, etc.).
How would this look?
- Baby or grandbaby is born.
- Start funding the 529 plan. You can use the five-year allowance to provide for maximum growth within the account.
- Stop funding the account after 15 years (allowing for no contributions within the last five years) (child will be starting school and will begin to use the funds).
- While the child is in school, re-evaluate whether all funds will be used by this one beneficiary or whether this account needs to be split between multiple students (if the account has more than $35,000 left over, move to another beneficiary).
- Once this child is out of school and starting to make money, begin moving the annual contribution limit to their Roth IRA.
- Start the process with the next beneficiary.
We will continue to monitor this issue for additional IRS guidance and clarity. If you have any questions or need assistance, please reach out to a professional at FORVIS.
- 1“IRA Contribution Limits,” fidelity.com.