If you're a parent, you no doubt want to give your child a solid financial future. Investing in a 529 plan for their education is a good first step, but you also want them to start saving for retirement as early as possible. That extra compounding time could make your mini-me into a mogul.
The problem: Because 529 plans are designed for education savings, you get penalized on withdrawals unrelated to education. But there's a big change coming. Beginning in 2024, it will be possible to roll unused 529 plan money into a Roth IRA. Let's explore how a 529 plan could help your child save for retirement.
Image source: Getty Images.
What's changing for 529 plans in 2024?
The $1.7 trillion spending bill President Biden signed into law in December 2022 contained a set of provisions called the Secure Act 2.0. The changes are meant to make it easier for Americans to save for retirement.
The big change you need to know about if you're a parent investing in a 529 plan? Under current law, 529 plan distributions unrelated to education are subject to income taxes plus a 10% penalty on the earnings portion of the withdrawal. But come 2024, the account owner (probably you if you're the parent) will be able to roll over up to $35,000 in unused 529 plan money into a Roth IRA for the beneficiary (your child) over their lifetime.
This change is significant for parents who worry their child may not use all their 529 money. For example, if your child chooses to attend a cheaper state university instead of a private institution or decides to skip college altogether, they could have unused 529 plan money. Though other options are available -- like transferring the money to another family member -- the Secure Act 2.0 allows parents to use that money to help their child build a nest egg.
When can you roll over unused 529 funds?
To roll over 529 plan money into a Roth IRA, the account must be at least 15 years old. Any contributions made in the past five years won't be eligible for a rollover.
Also, the amount you can roll over each year will be capped at the Roth IRA contribution limits. In 2023, for example, someone under age 50 can only contribute $6,500 to a Roth IRA. If this limit stays in place for 2024, you'd only be able to roll over $6,500. Then, in subsequent years, you could roll over an amount equal to the annual limit until you reach the $35,000 lifetime cap.
Couldn't I just contribute to a Roth IRA?
It's possible to fund a Roth IRA for a child if the child has earned income. Kids are subject to the same income limits as adults. Again, in 2023, the limit is $6,500 for people under 50 or the amount of earned income for the year -- whichever is less. So let's say your child earns $3,000 from babysitting in a tax year. Their maximum contribution for the year would be $3,000, regardless of whether it comes from you, your child, or a combination.
One advantage of choosing a Roth IRA over a 529 plan for your child is the flexibility: They can take penalty-free withdrawals for college. But be aware that while Roth IRA assets don't affect financial aid eligibility, withdrawals will count against your child on the Free Application for Federal Student Aid (FAFSA).
Assets in a 529 plan, however, have minimal impact on financial aid. So while a Roth IRA is a great way to give your child an early edge on retirement savings if they qualify, a 529 plan is typically a better vehicle for college savings.
Since Roth IRA rollovers will soon be permitted for unused 529 plan funds, these education accounts could help your child start saving for retirement early. And even if they do need all of that money for college, a 529 plan could allow your child to graduate with less student debt, which will help them prioritize retirement savings when they start their career.
