New Legislation Granting Greater Flexibility to College Savings Accounts

529 college savings plans are a great option to save for higher education. When it comes to saving for college with a 529 account starting early is recommended, so the account has more time to grow tax free. It is often encouraged to start saving for college even before you know where your child might end up, for example attending college or going to an applicable higher education institution like trade school.

There are other considerations when it comes to saving for college , for example if your child will receive a scholarship, or the cost of the college they choose to attend. With these uncertainties some might hesitate to contribute to a 529 account, but with new provisions passed by Congress at the end of 2022 there will be more flexibility with what you can do with the funding in a 529 account. These provisions will help ease worries about over funding a 529 account.

SECURE Act 2.0 implemented many new programs and provisions to help Americans save and plan for major life events like retirement and college. To encourage Americans to utilize the benefits of saving for college with a 529 plan they included a provision that allows 529 account owners to convert tax and penalty free the funds in a 529 account into a Roth IRA account. Previously if you had additional funds in a 529 account that would not be used for education expenses and you took a distribution to get the money out of that account you would be subject to income tax and a 10% federal tax penalty on any earnings related to the distribution.

This option to convert funds within a 529 tax and penalty free begins in 2024. There are some limits to this option. The lifetime limit of 529 to Roth conversions is $35,000 per beneficiary. Although there are certain instances where a 529 account owner can change the beneficiary of the account. The Roth IRA account must be in the name of the beneficiary, so you cannot convert 529 funds into a Roth IRA for someone besides the 529 beneficiary and in order to convert the funds in a 529 account to a Roth the account must be held for the designated beneficiary for at least 15 years.

The conversions are also subject to the annual Roth IRA contribution limits, but the upper income limit is not applicable. Another limitation to this is that no contributions or earnings on contributions can be converted in the five years prior to the conversion.  

Here is an example:

Robs parents began contributing to a 529 account for him in 1999 when he was born. His parents funded it until he turned 18 in 2017. Rob graduated from college in 2021 and found that his 529 account still has a balance remaining of $20,000. With this new provision of the SECURE Act 2.0 Rob found out that in 2024 he can convert the remaining balance into a Roth IRA account.

Because Rob’s 529 account was created at least 15 years ago and by the first transfer in 2024 no contributions will have been made in the last 5 years he can convert the funds in his 529 into a Roth IRA with the only limitation being the annual Roth IRA contribution limit, which is currently set at $6,500 a year.

Sources:

https://www.fidelity.com/learning-center/personal-finance/529-rollover-to-roth#:~:text=Starting%20in%202024%2C%20you'll,annual%20Roth%20IRA%20contribution%20limits.

https://www.journalofaccountancy.com/news/2023/mar/saving-college-new-529-to-roth-irs-transfer-rule.html

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