Secure Act boosts families’ 529 options
Congress gift-wrapped a lucrative yearend present to parents that adds flexibility on how to handle untapped money sitting in a 529 college savings account.
The Secure Act 2.0, which was approved late last month, includes a provision that allows tax- and penalty-free rollovers into a Roth retirement account of money stranded in 529s and no longer needed to pay college expenses. Certain conditions, of course, must be met.
This provision comes with a $35,000 lifetime cap on the rollovers and is set to go into effect in 2024. Currently, money in a 529 that’s withdrawn for non-education expenses can be subject to penalties and taxes.
For many families, sitting on a spare $35,000 in a 529 plan is a non-issue. They need to plunk down every dollar possible into the 529 to cover tuition and don’t have money to spare.
But having extra money in a 529 can happen, especially if your child gets hefty scholarships, chooses not to attend college, or you simply overfunded your account or chose a more affordable school. This new option allows parents to eventually reposition the extra funds from the child’s college account to a tax-advantaged Roth IRA.
This provision is not a carte blanche option for the wealthy. There are caveats:
The 529 plan must have been opened for at least 15 years before the rollover into a retirement account can occur.
The lifetime cap of $35,000 “limits the usefulness for families that have greater amounts of leftover money, such as for children enrolled in the military academies, who enroll in less-expensive colleges, and children who won scholarships,” said Mark Kantrowitz, author of “How to Appeal for More College Financial Aid.”
Capping the rollover means some families may have to make the transfers over several years to comply with Roth contribution limits.
Ted Rossman, a senior credit industry analyst at Bankrate.com, said the changes are positive because they could lead to more families participating in 529 plans.
He points to a 2021 survey by Fidelity Investments, which noted that only 19% of parents of high schoolers had a dedicated college savings account.
“I know many families are hesitant to open a 529 plan because they worry about what will happen to the money if their child doesn’t go to college or earns scholarships,” Rossman said. “I think being able to convert unused 529 funds into retirement savings without penalty could eliminate a key barrier to entry.”
Having earned income as a requirement to open a Roth IRA has not changed, Rossman said. “I think the main idea is that the child could benefit from these unused 529 funds as a kick-start to their retirement savings journey,” he said.
“In theory, this person would be working, even if they decided not to go to college or if they graduated with scholarships or had unused funds for some other reason … in any case, this would be a gradual process.”
While the 529 rollover option is far from perfect, making the plans more accessible and flexible is a step in the right direction.