Beneficiaries of qualified tuition programs under Section 529 of the Internal Revenue Code (“529 accounts”) will have a new opportunity starting January 1, 2024.  Under SECURE Act 2.0 (the “Act”), 529 account beneficiaries will be able to rollover funds from the 529 account into a Roth IRA without incurring tax or penalties providing certain requirements are met.

Broker-dealers and registered representatives (“advisors”) will want to know about this rule so as to advise families and students about the funding and related planning considerations for 529 accounts.

Background:

A 529 account is a type of investment account designed to encourage savings for future education costs.   However, withdrawals from 529 accounts must satisfy a number of conditions in order to avoid income tax and penalties.  For instance, the withdrawals must be for qualified education expenses and satisfy additional conditions.  This is a big disadvantage if the student cannot use or does not need all of the money in the 529 account.  As stated by the Senate Finance Committee’s summary of the Act: “This has led to hesitating, delaying, or declining to fund 529s to levels needed to pay for the rising costs of education… Families who sacrifice and save in 529 accounts should not be punished with tax and penalty years later if the beneficiary has found an alternative way to pay for their education.” The new rule under the Act is intended to address that concern.

New Opportunity

With the passage of this new rule, 529 account beneficiaries will have the opportunity to rollover leftover 529 funds to a Roth IRA without the imposition of income tax or penalties as long as the following conditions are met (many of which are intended to prevent the potential for abuse):

• The rollover must be to a Roth IRA for the 529 account beneficiary;
• The rollover from the 529 account to the Roth IRA must be paid via a direct trustee-to-trustee transfer;
• The aggregate amount rolled over during the 529 account beneficiary’s lifetime cannot exceed $35,000;
• The 529 account must have been in existence for at least 15 years prior to the rollover – This requirement is intended to prevent establishing and funding a brand new 529 account for the purpose of making a Roth IRA rollover;
• The rolled over amounts cannot include the 529 contributions and the earnings attributable to those contributions that were made five years before the transfer – This requirement is intended to prevent back-end funding of a 529 account in order to rollover this “new” funding to the Roth IRA;
• The transfer counts toward the annual contribution limit that applies to amounts contributed to an IRA for that beneficiary.  (While there is some industry uncertainty about whether the annual limit applies, the “safe” interpretation is to limit the contributions and transfers to the beneficiary’s IRA to the annual limit for contributions to IRAs until and unless the IRS issues guidance to the contrary.)

Conclusion

This new rule presents an opportunity that may be worth considering.  Advisors can help families contribute adequate amounts to 529 accounts for education expenses with the comfort that at least $35,000 of excess funding can ultimately be transferred to a Roth IRA for the 529 beneficiary.