Congress Just Gave Education Savers a Roth IRA Boondoggle

The end of the year is often a busy time for lawmakers, and that’s been especially true in 2022. With the federal government working hard to get its annual appropriations bill finalized, proponents of various pieces of legislation have done their best to get their proposals included in the year-end package.

Those looking for retirement reform got a victory when provisions of proposed legislation collectively known as SECURE 2.0 made it into the final spending bill that the House and Senate have now approved. One of these provisions will give those who save for education through 529 plans the ability to move some unused funds to help their loved ones get an early start on their retirement savings when they’re done with college.

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A new 529-to-Roth rollover

Under the new legislation, those who have education savings in 529 plans would be able to take unused money and roll it over into a Roth IRA for the beneficiary of the 529. The new provision would become available starting in 2024.

There would be some limitations on the use of the new provision. The amount of rollovers in any one year wouldn’t be able to exceed the annual contribution limit to Roth IRAs, which is currently $6,000 for 2022 and will rise to $6,500 in 2023. In addition, a lifetime limit of $35,000 applies for total money moves from 529s to Roth IRAs.

In addition, the rollover option is available only for 529 plans that have been open for at least 15 years. Account owners can’t roll over any contributions or earnings on those contributions from the most recent five years. This limitation is intended to prevent people from jumping into 529 plans for short-term use just to take advantage of the Roth provision.

Solving a perceived problem…

Proponents of the measure argue that current law dissuades some would-be savers from taking full advantage of 529 plans because of the uncertainty of how much money they’re likely to need and what could happen if they overestimate their eventual college expenses. If those who save in 529 plans have to take withdrawals for purposes other than qualified educational expenses, they typically have to pay income taxes plus a 10% penalty on any earnings that the 529 plan’s investments generated.

Allowing a rollover to a Roth would avoid the taxes and penalties. Even better, it would preserve tax-free treatment of the money inside the retirement account throughout the beneficiary’s lifetime, allowing investments to grow with nothing lost to taxes, even when the money gets taken out in retirement.

…but a problem for whom?

Critics of the measure, though, note that there are no income restrictions tied to the rollover provisions. As a result, they argue, those who are wealthy enough to put excess levels of funding toward 529 plans are most likely to benefit from this legislation. Those of more modest means are more likely to need the entire amount of their education savings to go toward its intended purpose — spending on educational expenses.

Interestingly, the new provision could actually end up changing the way many families approach 529 plans. Because one can change the beneficiary of a 529 plan, many families with more than one child have planned to take any unused 529 assets from their oldest child and use them to support younger children’s educational expenses. Now, though, the rollover provision opens the potential for more sophisticated estate planning that essentially uses the 529 plan as a broader wealth-transfer tool.

Start planning now

Finally, 529 plans are already a great way to save for college, and the new Roth rollover provision will give people an extra incentive to put money into 529 accounts. Meanwhile, for those already in position to take advantage of the rollover, you’ll have 2023 to do your planning before the provision takes effect in 2024.

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