When it comes to investing, there’s a plethora of technical jargon standing in the way of your money management – what’s a fiduciary? How does a bond work? When would early withdrawal from your IRA make sense?
Fortunately, there are also financial guides (AKA advisors) out there to help you make sense of your money (like the team here at Clarity!). One of the latest pieces of news we’re demystifying is the recent SECURE 2.0 Act, which was officially signed into law by Congress in December of 2022.
The Act has many wide-sweeping changes, but one of our favorites is that individuals can now make 529 to Roth IRA conversions. Today, we’ll be exploring what these types of accounts are used for, as well as what you need to know about the new rules surrounding 529 conversions.
529 vs Roth IRA Accounts: What’s the Difference?
People love Roth accounts because investments in these retirement accounts grow tax-free. Many of our clients love them so much that they ask about making contributions for their children or grandchildren as well, imagining how much compounding growth those accounts could generate over a lifetime. Unfortunately, unless your child is earning income, they can not contribute to Roth accounts, so many parents focus instead on funneling their savings into 529 College Savings Plans.
A 529 College Savings Plan is an investment account used specifically for education. In a 529, you can invest in professionally managed portfolios of stocks, bonds, and other securities tax-free – as long as the money is used for higher education expenses. If not, you incur a penalty when you pull your money back out. This restriction gives many parents pause because they are not sure about their child’s college plans.
And this is why we love this new provision of the Secure Act, which allows you to convert 529 funds to Roth IRAs – a win-win!
The New Rules for Rollovers
Many people use 529 accounts to help save for their children’s college costs, but then end up with a little leftover. What happens if you save in a 529 for two decades, only for your child to receive a full-ride scholarship? In these instances, they would have to either continue saving it in the 529 (until another higher education expense came along) or withdraw the money with a penalty.
That’s where the SECURE 2.0 Act changes things. The new rules would allow individuals to rollover (i.e., transfer) up to $35,000 from a 529 to a Roth IRA account in their name. Of course, there are some guidelines around these transfers.
Read on to explore the five things you need to know about 529 to Roth conversions – including annual contribution limits, rollover windows and more.
5 Things to Know About 529 to Roth IRA Conversions
1. SECURE 2.0 isn’t fully in effect yet
The SECURE Act doesn’t just cover 529 to Roth conversions – it’s a large bill that aims to improve retirement savings for individuals and employers. With several moving parts to the bill, Congress has set different dates for when various rules go into effect. Some were immediate, while others won’t be enforced until 2024, 2025 or even later.
Specifically, 529 to Roth IRA conversions won’t be possible until 2024. If you’re curious about other portions of SECURE 2.0 and when they begin taking effect, it’s best to consult with your financial advisor.
2. The 60-day rollover window isn’t applicable
The IRS has something called a “60-day rollover window,” which means that when you “rollover” (i.e., transfer) funds from one tax-advantaged retirement account to another, you have 60 days to deposit and re-invest the money to avoid any tax penalties.
However, with a 529 to Roth IRA conversion, you must move the money directly – without that 60-day window. That means that the funds must come from a 529 in your name and go into a Roth IRA in your name without any middle steps.
3. Your 529 account must be at least 15 years old
Another big sticking point is the age of the 529 account. You can’t open a 529 account and immediately transfer the funds tax-free to your Roth IRA account.
Rather, your 529 account must be at least 15 years old. Along those same lines, any money contributed to the 529 in the last five years (and any earnings from those contributions) doesn’t qualify.
4. There is a yearly contribution limit
Although the rule now allows up to $35,000 to be transferred per person, that number can’t be used all at once – there are yearly contribution limits.
In general, the most you can move from your 529 each year is the same as the maximum IRA contribution limit for that year, and that number isn’t in addition to your regular contribution.
For those under 50 years of age, the contribution limit is $6,500 in 2023. That means that if you’ve already contributed $6,000 to your IRA this year, you would (hypothetically) only be allowed to transfer $500 from your 529 to your Roth IRA.
5. The new rules may make 529 plans more available in the workforce
A recent article on the subject from PlanAdvisor quotes Barrett Scruggs, the Vice President of workplace financial wellbeing at SoFi at Work:
“Employers can offer 529 plan benefits as part of a comprehensive financial wellness program that is appealing to employees from different age groups and with different financial wellness needs.”
Although individuals can invest in 529s on their own, contributions given through employers could simplify the process for many.
Plus, Scruggs points out that 529s are useful for employees with student debt, currently enrolled in college, and those who plan to have children or have children expecting to attend college.
If you have a 529 account or plan to in the future, being aware of these new rules and their implications can help you take a tax-advantaged approach to your financial planning. And if you have any questions along the way, a financial advisor can help you decide which account options are best for your goals.
Optimize Your Savings with Clarity
We’re here to help you make sense of your financial planning options. Click here to get in touch with a member of the Clarity team today and get started.