After inflation surged in 2022 to a peak not seen since the 1970s, many people are understandably concerned about whether they will be able to retire comfortably. To help put that goal more within reach again, late last year, Congress passed and President Joe Biden signed the SECURE 2.0 Act, which significantly updates U.S. retirement planning law. Among the numerous clever changes contained in the act was one relating to 529 college savings plans. Now, it is possible to repurpose unused 529 funds -- previously earmarked for qualified education expenses -- to help finance your retirement.
Here's how the SECURE 2.0 Act aims to make life a little easier for beneficiaries of overfunded 529 plans.
The problem of overfunding a 529
To be clear, a 529 account is a tax-advantaged investment vehicle used to save and invest for qualified education expenses such as college tuition or apprenticeship costs. Parents and other relatives can contribute substantial amounts to a young person's 529 plan with the intent that those dollars -- and their investment gains -- will fund the child's future higher education.
The dividends and investment gains those funds accrue along the way are exempt from taxation, which can be an especially enticing benefit for those with large taxable investment accounts already generating sizable income.
While the maximum size annual state tax deduction for contributions to 529s is $10,000, many people choose to contribute much more than that. This is sometimes referred to as "super-funding" a 529. The more money that is contributed to a 529 plan early on, the more the student to whom it is assigned will have to spend on their education later, and the more money their parents and relatives will have saved in capital gains taxes and other investment income taxes along the way.
However, some people had historically been faced with the threat of over-contribution to these plans -- in which the young person ends up with too much in their 529 plan and no further education costs to cover. Any money withdrawn from a 529 that is not spent on education expenses faces federal income taxes plus a 10% penalty -- a pretty steep penalty given that people with the means to have overfunded a 529 are likely already in high tax brackets.
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The pathway from 529 to Roth IRA
The SECURE 2.0 Act, signed into law on Dec. 29, 2022, provides some tax relief to people with larger-than-necessary 529 plans. The act allows rollovers of up to $35,000 of those excess funds into a Roth IRA for the original beneficiary. That is, unused 529 dollars originally meant for your education can be seamlessly shifted into a Roth IRA, one of the most popular tax-advantaged retirement savings accounts.
The fine print matters here. Among the important details and caveats:
- The Roth IRA rollover option is available to 529 plan beneficiaries, not 529 account owners.
- The beneficiary may roll over up to a lifetime maximum of $35,000 from a 529 plan into a Roth IRA.
- The 529 plan must have been open for at least 15 years prior to the rollover.
- Contributions and earnings must have been in the 529 plan for at least five years before being rolled over.
- Normal annual Roth IRA contributions limits still apply. ($6,500 per year for people under 50, $7,500 for those over 50.)
In the end, this provision of the SECURE 2.0 Act is a nice benefit for people who find themselves with too much money in their 529 plans -- although, in truth, having an overfunded college savings fund isn't an especially terrible problem to have. Still, giving people the option of rolling those leftover funds into a Roth IRA is clever -- providing an incentive to make wise use of money that would otherwise be taxed and penalized at a fairly high rate. The new process can provide some additional tax-free retirement money to members of younger generations, which, from nearly all angles, is a positive turn.
