Are 529 Plan Rollovers the New Backdoor Roth?
While there are not millions of people overfunding 529 plans, this does give assurance to parents and grandparents who are saving for college, he said. With this new rollover pathway, the money can be repositioned for their children or grandchildren to become retirement savings, in cases where their 529 beneficiary goes to a cheaper school, gets a scholarship or does not attend college.
Before the adoption of Secure 2.0, families were penalized for withdrawing unused or leftover funds from their 529 accounts. Now, as Losi pointed out, families have an option other than simply withdrawing the funds and paying the excise taxes should their child decide against pursuing a higher degree — or complete their education without using all funds in the account.
“Depending on how the regulations shake out, I think this could be a very big deal for clients,” Losi said. “It appears that you will be able to supercharge the retirement savings of younger beneficiaries who don’t end up needing the money for education.”
As Losi explained, while a single beneficiary will only be able to inherit $35,000, this money will be sheltered within a Roth IRA and will have years, likely decades, to grow. And, the initial amount can be complemented by the younger account owner’s own future contributions or rollovers.
“I think we are likely to see regulations that aim to prevent abuses, but this will still represent a great opportunity for clients to create some tax diversification in their retirement wealth,” Losi said.
‘Devil Is in the Details’
While many advisor professionals are eagerly assessing the 529-to-Roth conversion, others are voicing a note of caution. For example, a new analysis published by Ian Berger, an attorney and IRA analyst with Ed Slott and Co., suggests the new rollover opportunity sounds more exciting than it is.
“We’re getting a lot of questions about the [Secure 2.0 Act] provision allowing tax-free rollovers from 529 plans to Roth IRAs,” Berger writes. “Although this new rollover opportunity sounds exciting, there are a number of restrictions that may limit its appeal.”
According to Berger, “as usual, the devil is in the details.” His reading of the law is that the $35,000 limit is indeed meant to be a lifetime maximum for a given 529 account owner, meaning they would not be able to distribute more than this amount by sequentially naming new beneficiaries. He expects this will be clarified by regulation or technical legislative correction.
“The 529 plan must have been open for more than 15 years,” Berger adds. “It is not clear whether a new 15-year waiting period is required when someone changes 529 beneficiaries or if the waiting period that applied to the prior beneficiary can be tacked on. We’ll need further clarification from Congress or the IRS.”
A further challenge, according to Berger, is that rollover amounts cannot include any 529 contributions or earnings on those contributions made in the preceding five-year period. And finally, rollovers are still subject to the annual Roth IRA contribution limit, meaning rollovers of sizable accounts will take years of coordinated planning.
“So, for example, if the Roth IRA contribution limit in 2024 remains $6,500, then no more than $6,500 can be rolled over from a 529 to a Roth IRA in 2024,” he writes. “Further, any actual Roth IRA (or traditional IRA) contributions made by the 529 beneficiary would count against the $6,500 limit. The effect of this rule is that a full $35,000 529-to-Roth IRA rollover would need to be done over several years. It also means that the 529 beneficiary doing the rollover must have compensation in that year at least equal to the amount being rolled over.”
He adds, however, that the income limits on Roth IRA contributions don’t apply.
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