Starting this year, some of the money in 529 college savings accounts can be used for retirement if it is not needed for education.
New rules under the federal law, known as Secure 2.0, allow up to $35,000 in a 529 account to be transferred to a Roth individual retirement account for the 529 account beneficiary if certain conditions are met.
Government-sponsored 529 accounts, named after a section of the tax code, are used to pay for educational expenses—primarily college expenses. Money deposited into the accounts grows tax-free and can be withdrawn tax-free to pay for eligible expenses such as tuition, housing, food and books.
The new Roth option is aimed at parents who may be reluctant to save in a 529 account because they fear having to pay income taxes and a penalty if, for some reason, the funds are not needed for college and they withdraw the money want.
“It’s parents’ biggest objection to opening a 529,” said Vivian Tsai, chairwoman emeritus of the College Savings Foundation, a group that includes major financial firms that run the government’s college savings programs. “The barrier is really psychological.” (Ms. Tsai is also a senior director and director of relationship management for the education savings division at TIAA, a large investment firm that manages 529 plans in seven states.)
Many families find it difficult to save for college, and accumulating “too much” money is usually not a problem. “The vast majority of account holders are not saving enough,” Ms. Tsai said.
The average estimated annual cost of attending a four-year public university was about $28,000 for the 2022-23 school year, while at a private four-year college it was nearly $58,000. However, according to the College Savings Plans Network, a group that represents federal 529 plans and is a proponent of the Roth rollover option, the average 529 account balance was about $28,000 in mid-2023.
Still, there may be circumstances in which funds remain—for example, if a student decides not to attend college, chooses a less expensive school, or receives scholarships to cover much of the cost. Knowing there is a way to roll the money into a Roth plan could help overcome any reluctance to open a 529, said Peg Creonte, president of government savings plans at Ascensus, which has 43 education savings plans in 26 states and supported in the District of Columbia.
“Families fear their money could be lost,” she said. “The real benefit is that it breaks down a barrier.”
There was already a way to use unused 529 funds tax-free – by simply naming another family member, such as a sibling, grandchild or spouse, as the beneficiary of the account for education expenses. (Ms. Tsai said she did this, transferring the funds saved in her son’s account to his younger siblings, whose tuition costs were higher.) Parents can also be named as beneficiaries of the account if they want to support their own education.
To qualify for the Roth rollover option, the 529 account must have been open for at least 15 years and no contributions or earnings from the past five years can be rolled over. In total, up to $35,000 can be transferred – but transfers are limited to the maximum annual Roth contribution, which is $7,000 in 2024 for those under age 50. To reach the maximum transfer amount, the money would have to be moved over several years.
Other rules may also apply. For example, to contribute to a Roth, a saver must have earned income, and contributions for a given tax year cannot be more than what the saver earned, said Pam Lucina, chief trust officer at Northern Trust, a financial services firm . (The Investment Company Institute, a group that represents regulated mutual funds, has asked the Internal Revenue Service to confirm that these rules apply to transfers from a 529 to a Roth.) There is no tax deduction for Roth contributions, but the accounts are grow tax-free and the funds are not taxed when paid out.
Ascensus estimates that 15 percent of its approximately 6.5 million 529 accounts would be eligible for the rollover option, Ms. Creonte said, adding that the administrator recorded 768 rollovers on Roths in January.
However, the federal government has not yet issued formal guidance on the Roth rollover option, so some questions remain unanswered. The Investment Company Institute, for example, has also asked the Treasury Department and IRS to clarify whether changing the beneficiary of a 529 account would “restart” the 15-year holding period.
If this were the case, a change in beneficiary could complicate Roth rollovers. For example, a parent who wants to become the beneficiary of the account and transfer the money to their own Roth IRA would have to wait much longer to do so.
The College Savings Plans Network sent a letter to the federal government in September saying it did not believe a beneficiary change or other administrative changes should reset the 15-year clock and asked for confirmation of that policy.
But at least one 529 plan — Pennsylvania’s — posted a warning on its website saying that the Treasury Department may ultimately disagree with the College Savings Plans Network’s interpretation and that it “should not be construed as legal or tax advice.” may become”.
“I would be cautious about a beneficiary change if you think you can do a Roth rollover,” said Chris Lynch, president of TIAA’s tuition financing program.
Since unused funds can simply remain in the 529, it may make sense to wait until further details are clarified. “There’s no need to rush,” said Rob Williams, managing director of financial planning at Charles Schwab.
However, according to the Investment Company Institute, there is a deadline – this year’s federal tax filing deadline – if a saver wants to transfer funds from a 529 to a Roth and have the contribution counted for the 2023 tax year. A large 529 plan, Virginia, also references the deadline on its website.
Another problem is that some states offer a tax deduction for residents who contribute to a 529 account. These states may require a return of state tax savings when 529 funds are rolled over into a Roth. It’s best to consult a tax advisor to find out how an extension may affect your finances.
Here are some questions and answers about 529 accounts and Roth rollovers:
Do rollovers from a 529 to a Roth count toward the annual maximum IRA contribution?
Yes. Contributions – including rollovers – cannot exceed the maximum allowable IRA limit each year.
What can I use 529 funds for other than college expenses?
The funds saved in the 529 can be used to finance tuition fees from kindergarten to high school as well as for apprenticeships. Additionally, up to $10,000 from a 529 can be used to pay off student loans.
If you use the funds for nonqualified purposes, you’ll generally have to pay ordinary income tax as well as a 10 percent tax penalty on the amount withdrawn — but only on the portion of the withdrawal that’s attributable to income, Schwab’s Mr. Williams said.
Source link
2024-02-16 14:00:21
www.nytimes.com
