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SECURE Act 2.0 Allows Tax Free 529 Rollovers to Roth IRAs

February 02, 2023

Attention parents…the SECURE 2.0, signed December 29, 2022, allows 529 funds to be rolled into a Roth IRA for the beneficiary. Here’s what you should know.

Parents, do you have a 529 plan for your child(ren)? You will want to read up on some changes under the recently passed retirement plan act, SECURE 2.0. We have the details here.

What is SECURE 2.0?

The Securing a Strong Retirement Act, H.R. 2954, otherwise known as SECURE 2.0 expands and increases retirement savings and simplifies some existing rules. Check out our blog, SECURE 2.0 Raises RMD Age to 73 for details on some specific changes made under SECURE 2.0.

What is a 529 plan?

A 529 plan is an education savings plan operated by a state or educational institution. These plans are relatively hands off and work much like a 401k or IRA with your contributions invested in mutual funds or similar investments. Your account will go up and down in value based on the particular investment’s performance in the stock market.

The major advantage of the plan is its tax benefits. Although contributions are not deductible federally, earnings in a 529 plan grow tax-free and will not be taxed as long as the money is withdrawn to pay for specific college-related expenses such as tuition, fees, room and board, and course materials.

Under previous guidance, money withdrawn and spent on unqualified expenses was subject to income tax and a 10% penalty on the earnings.

What did SECURE 2.0 change?

The main drawback for 529 plans has always been that some children cannot fully benefit from them, due to the qualified expense caveat. This led to many families hesitating or declining to fund 529s. SECURE 2.0 permits Section 529 beneficiaries to make direct, trustee-to-trustee rollovers from a Section 529 account to a Roth IRA, without tax or penalty.

This means that the 10% penalty can be waived if:

  • Your child wins a scholarship
  • Your child enters the U.S. military
  • Your child receives tuition support from an employer

In the past, you could avoid the 10% penalty by transferring the 529 to yourself, a spouse, or another beneficiary—but you were then obligated to pay the penalty and the tax.

Thanks to this change under SECURE 2.0 you no longer have to do this workaround to avoid the penalty.

When does the rollover allowance start and are there any limits?

The allowance is effective for distributions made post December 31, 2023. There are a few limits as well:

  • The rolled over amount cannot exceed the Roth contribution limit ($6,500). The rollover contributions are not subject to the Roth IRA income limits ($153,000 for single filers, $228,000 for joint filers)
  • You cannot rollover more than $35,000 in the beneficiary’s lifetime
  • You cannot rollover contributions or earnings from the last five years
  • The 529 plan must have been open for at least 15 years

The IRS is hopeful that this allowance will encourage more families to set up and fund 529 plans for their children. This is a good way to jump start retirement accounts for children and reduce 529 account balances if your family is worried about the 529 account balances are greater than the education cost expectations.

Questions? Contact us.

Visit our SECURE Act 2.0 Knowledge Center for more information on retirement changes that could impact you and your business.

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