Many parents, grandparents and others have saved for a child’s future college expenses through a 529 college savings plan, a tax-advantaged investment vehicle. It’s an excellent way to save for rising college costs. Funds may be withdrawn tax-free to pay for IRS-qualified expenses such as tuition, room and board, books, and computers. In 2019, the passing of the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) also permitted account holders to use a portion of 529 funds to pay student loans tax-free.
However, the plans have strict rules regarding withdrawals for nonqualified expenses, making some hesitant to take advantage of an otherwise appealing savings option. When distributions are taken for nonqualified expenses, earnings are subject to a 10% penalty and will incur federal taxes. So if the beneficiary decides not to go to college, quits before using all funds, or the account is simply overfunded, withdrawals may incur a penalty.
SECURE 2.0 Act, passed in December 2022, helps alleviate the overfunding concern. Effective in 2024, distributions for nonqualified expenses may be rolled over to a Roth IRA for the beneficiary without penalty or taxation. There are specific requirements, including but not limited to:
The forthcoming ability to convert 529 funds to a Roth IRA offers families a unique legacy planning opportunity. To set up a 529 plan, visit collegesavings.org and find your state’s plan. If you are interested in converting excess 529 funds to a Roth IRA, contact me or one of my colleagues for assistance.
Sources:
USNews.com, “A Look at College Tuition Growth Over 20 Years,” September 20, 2022.
Forbes.com, “529 Plan Rollover to a Roth IRA,” April 12, 2023.
TheStreet.com, “How to convert a 529 plan to an IRA,” June 22, 2023.
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