Lifepoint Financial Design – LifePoint Financial Services – Mike Metzger Financial Planning

Recently, congress passed the most significant tax law changes since the Tax Cuts and Jobs Act. The bill being called the Secure Act 2.0 builds upon the first Secure Act and enhances much of the retirement specific income tax laws. And there really is a lot to be celebrated there, such as deferred required minimum distributions (RMDs) and more favorable retirement plan contributions.

But, one of the most publicized tax law changes is the new ability to convert unused 529 college savings plan funds to a Roth IRA. This is something that has been a sore spot for a lot of parents saving for their kids’ education in a changing technological landscape. With the increasing access to information and specific niche knowledge from successful and qualified influencers, it’s becoming more questioned as to why pricey college education is necessary. And, rightfully so.

When it was announced that the Secure Act 2.0 would include the ability convert unused 529 funds to a Roth IRA without tax or penalty, many people applauded that overdue change.

As it currently stands, any money withdrawn from a 529 college savings plan that is not used for qualified education expenses, receives a 10% penalty on top of ordinary federal income taxes. That could equate to up to 50% + tax hit!

But for those applauding this new tax law change, it’s not exactly what you think it is…

Here are some of the restrictions to converting your child’s 529 college savings plan over to a Roth IRA:

1.     The new tax law does not take effect until 2024. This new tax law cannot be implemented until 2024, which means, it’s unavailable for this tax year.

2.     The Roth IRA must be owned by the same 529 beneficiary. Whichever child was listed as the beneficiary of the 529 college savings plan, must also be the account owner of the Roth IRA that the funds are being converted to. So, for those parents who thought they can shift those unused 529 funds to their own retirement account, are sadly mistaken.

3.     The beneficiary must have compensation. This can be a challenging requirement, especially if the child is a full-time student without the time for work. However, it is thought that this provision is likely to be removed.

4.     The 529 plan must have been established and maintained for at least 15 years. This is the first provision that will eliminate many 529 plan owners. Not every parent starts their child’s 529 plan early. In fact, I would bet that most don’t start one until their child is in double digit age.

5.     Contributions made within 5 years of the desired Roth conversion will not qualify. So, at conversion, those contributions in the 5 years prior cannot be converted to the Roth IRA. This, also, is a big hurdle for 529 plan owners to conquer.

6.     529 funds converted are limited to the Roth IRA contribution limits. Unfortunately, if there are significant unused 529 plan funds, you cannot just move it all over into the Roth IRA account. Those 529 funds will have to be converted in smaller chunks ($6500 Roth contribution limit in 2023) over the course of years.

7.     Lifetime limitation on converted 529 plan funds of $35,000. College tuition at most 4 year colleges is greater than $35,000 for a single year. So, if you funded more than one year of college, and your child didn’t go college, then you will end up with a lot of money subject to taxes and the penalty.

I’m encouraged that Congress saw the need to add flexibility to unused college savings, but they made the restrictions pretty tough to overcome. The amount of 529 plan owners who can pass all of these restrictions, has to be fairly minimal.

If you have any questions, shoot me a message.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

 his information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Prior to investing in a 529 Plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing. Non-qualified withdrawals may result in federal income tax and a 10% federal tax penalty on earnings.

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