Secure Act 2.0: New Planning Opportunities for 529 Accounts

Unless you have a crystal ball, estimating how much to save for future tuition costs can be tough.  529 plans are a popular financial tool for accumulating education savings and are at their most powerful when started early in a child’s life, but uncertainties abound.  What will future college tuition be?  How much will the account grow?  Will your student qualify for scholarships?  Will he or they go to grad school?  Will he or they even go to college at all?

Thanks to these uncertainties, it’s not uncommon for us to meet investors with 529 account balances remaining even after qualified education expenses are fully paid.  Planning options for these overfunded 529s include changing the beneficiary to another qualified family member, using a limited amount of the funds to pay off student loan debt, or cashing out the excess 529 funds by paying income tax and in most cases, a 10% penalty on the earnings. The new Consolidated Appropriations Act of 2023, passed by Congress in December 2022, includes a retirement bill known as SECURE Act 2.0 that provides an additional, though restricted, planning option for some 529 account owners.

Section 126 of SECURE Act 2.0 enables some individuals, beginning in 2024, to roll 529 plan money directly into a Roth IRA for the 529 beneficiary.  On its surface, that sounds like a financial planning slam dunk for those with 529s that have been overfunded, but Section 126 comes with restrictions that limit its usefulness and by design, any potential abuse of the provision.  It’s also important to note that Treasury Regulations and additional guidance from the IRS on this provision could be forthcoming at any time, which may change the current interpretations of Section 126. 

Restrictions on the new 529-to-Roth Rollovers 

Here’s a look at the conditions and restrictions on making a valid rollover from a 529 plan to a Roth IRA under Section 126 of SECURE Act 2.0, effective beginning in 2024. 

• The 529 plan must have been in place for 15 years or longer.  
• Any contributions to the 529 plan made within the last 5 years, along with the related earnings, cannot be moved to a Roth IRA. 
• The maximum amount that can be rolled from a 529 plan to a Roth IRA during an individual’s lifetime is $35,000. 
• The annual limit on the amount that can be rolled from the 529 plan to a Roth IRA is equal to the IRA contribution limit for the year, less any other traditional IRA or Roth IRA contributions made for that year.  In other words, Section 126 does not increase the overall annual contribution limit to an IRA. 
• A rollover of funds from a 529 requires that the owner of the Roth IRA have earned income, just as would be required to make a regular Roth IRA contribution.
• The Roth IRA must be in the name of the 529 plan beneficiary, not the 529 plan owner.
• 529 earnings rolled into a Roth IRA retain their characterization as earnings within the Roth IRA.  While Roth IRA contributions can be withdrawn tax- and penalty-free at any time, certain conditions must be met to withdraw earnings from a Roth IRA both tax- and penalty-free.   Accordingly, owners of Roth IRAs that were even partially funded by a 529 should tread carefully and consult their tax advisor if they plan to make an early, pre-retirement withdrawal from the Roth account.

Planning Opportunities Using 529-to-Roth Rollovers 

Given the restrictions above, it’s clear that stuffing 529s with contributions as a means to funding Roth IRAs is a no-go.  That said, the 529-to-Roth rollover does offer the straightforward benefit of being able to repurpose up to $35,000 of an overfunded 529 into retirement savings.  It also presents a few other potential planning opportunities for some individuals or families. 

First, Section 126 could make adding funds to a Roth IRA possible for an individual whose income is too high to make a regular Roth IRA contribution.  The ability to make a regular Roth IRA contribution is phased out for individuals whose Modified Adjusted Gross Income (MAGI) exceeds an applicable threshold, which for 2023 starts at $138,000 for single and $218,000 for married filing jointly taxpayers.  Rollovers of 529 funds to Roth IRAs under Section 126 will not be subject to those income limitations. Higher-income individuals often work around the MAGI threshold by making a so-called “Backdoor” Roth IRA contribution, but that technique may involve complexities that a 529 rollover would avoid. 

An additional planning opportunity may arise for some higher-net-worth parents or grandparents who have the means to both pay for education costs and seed a retirement account for a child.  A 529 plan could be funded at the child’s birth, and once the 529 account has been in existence for 15 years–for example at the child’s 16th birthday–the parents or grandparents could begin to move 529 money into a Roth IRA for the child, up to the annual maximum IRA contribution limit.  As noted in the restrictions above, the child must have earned income to be eligible for these Roth IRA contributions, perhaps from a part-time or summer job.  This annual transfer could continue each year until the $35,000 lifetime rollover limit is reached, and because the retirement money in the Roth IRA is being seeded so early, a significant sum could accumulate by the time the child retires. 

The 529-to-Roth Rollover Doesn’t Change 529 Best Practices 

Despite this new 529-to-Roth IRA rollover provision effective in 2024, best practices around funding 529 plans haven’t changed, and include the following concepts: 

• The primary purpose of funding a 529 Plan is to cover educational costs, and owners should avoid intentionally overfunding them by significant amounts. 

• Parents with limited resources should generally focus on building up their own net worth and retirement assets before they allocate funds to 529 Plans.   
• A 529 account owner with money remaining in the 529 after the beneficiary graduates from college should first consider changing beneficiaries to other qualified family members, before using the new 529-to-Roth IRA rollover technique.   

Overall, the limitations included in the 529-to-Roth rollover rule, along with further guidance likely to come from Treasury and IRS, mean that this new provision does not fundamentally change the education planning landscape. It’s another tool in the toolbox, and one that your TCI Team will be glad to explore with you.