What Do You Do If You Save Too Much in a 529 Account?
Congratulations! Getting a child through college with little to no debt is quite the accomplishment. However, you now have a conundrum. What do you do with the funds you have left in their 529 college savings account?
Historically, you have had three options; leave it in the 529 college savings account in case the need for further higher education arises, change the beneficiary to another family member so they can use it for higher education, or withdraw the funds in a nonqualified withdrawal and pay taxes. Now, you have a fourth option. The Secure 2.0 Act changed the law so that you can now roll a portion of your 529 savings accounts over as Roth IRA contributions for the beneficiary. This can be a great option if your goal is to give the beneficiary a great start in their career by propelling them down the path to a prepared retirement. However, there are a few rules and limits that must be strictly followed to take advantage of this option.
Laura Saunders of the Wall Street Journal summarizes these as follows, “To be eligible, a 529 account must have been open at least 15 years, and rollovers cannot be contributions added in the last five years. The rolled-over funds also must go directly from the 529 plan into a Roth IRA owned by the beneficiary. In addition, 529-to-Roth IRA rollovers cannot exceed a total of $35,000 per beneficiary, although it’s unclear how this will be tracked. However, someone who owns several 529 accounts—say for different children or grandchildren—could have a $35,000 rollover limit for each one.”
Additionally, the beneficiary is somewhat limited. The total Roth contribution for the beneficiary each year cannot exceed their earned income or the limit on Roth contributions by the IRS. For example, if the beneficiary has $5000 of earned income in 2024 the maximum that can be rolled over this year is $5000. If the beneficiary has more than $7000 of earned income, the rollover amount could be up to $7000. It is important to note that the limit is the total between rollovers from the 529 college savings account and the beneficiary’s own contributions. You cannot make both unless the combined amount is under the limit. However, for 529 college savings account rollovers they have waived the normal income limitations so higher earners can make Roth contributions using funds from 529 college savings accounts.
This new option offers many advantages to those with funds left in their 529 college savings accounts that they don’t foresee using for higher education costs. However, there are a few things that we still need clarity on. First, are these rollovers going to be treated as tax-free by the states? Currently, 9 states including Missouri have not declared if they will tax these rollovers in any way. The other states are split on this issue. Second, does the 15-year clock restart if the beneficiary is changed? This is important due to the restriction that the rollovers must go to a Roth IRA for the named beneficiary. Third, it is still not clear what reporting requirements the IRS will have on these transactions. This means that not all custodians of 529 savings accounts and Roth IRAs are prepared to do these transactions. Finally, if for some reason the rollover to the Roth IRA triggers a tax penalty it is not clear whether the owner of the 529 college savings account or the beneficiary would owe those taxes. In conclusion, while we may want more clarity before doing these rollovers, it is something to watch closely as the law develops so that we can take advantage of this new opportunity.