New Change to 529 College Savings Plans: 5 Benefits From the Change You Need to Know
Starting in 2024, you can roll unused 529 plan funds to a Roth individual retirement account, without taxes or penalties. Here’s what to know.
Understanding 529 College Savings Plans
If you have children or are planning for your own education, a 529 college savings plan can be a valuable tool to save money for future educational expenses. A 529 plan is a tax-advantaged investment account designed to encourage saving for future college expenses. It allows you to contribute funds that can grow tax-free and be withdrawn tax-free when used for qualified education expenses.
What Are the Key Features of a 529 Plan?
Here are some key features of a 529 plan:
- Tax Advantages: Contributions to a 529 plan are not deductible on your federal tax return, but the earnings in the account grow tax-free. Withdrawals are also tax-free when used for qualified education expenses.
- Qualified Education Expenses: Funds withdrawn from a 529 plan can be used for qualified education expenses, including tuition, fees, books, supplies, and certain room and board expenses.
- State Tax Benefits: Some states offer additional tax benefits for contributions to 529 plans, such as deductions or credits on state income tax returns.
- Rollover Flexibility: Starting in 2024, unused 529 plan funds can be rolled over to a Roth individual retirement account (Roth IRA) without incurring taxes or penalties.
Understanding the New Change
One significant change to 529 college savings plans is the ability to roll unused funds into a Roth IRA without taxes or penalties. This change is set to take effect in 2024 and provides additional flexibility for account holders.
What Is a Roth IRA?
A Roth IRA is an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement. Unlike traditional IRAs, contributions to a Roth IRA are made with after-tax dollars, meaning you don’t get a tax deduction when you make the contribution. However, the earnings in the account can grow tax-free, and qualified withdrawals in retirement are not subject to income tax.
Benefits of Rolling Over Unused 529 Plan Funds to a Roth IRA
The ability to roll over unused 529 plan funds to a Roth IRA offers several benefits:
- Tax-Free Growth: By rolling over the funds, you can continue to benefit from tax-free growth within the Roth IRA.
- Withdrawals for Any Purpose: Unlike 529 plans, which can only be used for qualified education expenses, funds in a Roth IRA can be withdrawn for any purpose without penalty, provided you meet the age and holding period requirements.
- Estate Planning: Unused 529 plan funds can be passed on to beneficiaries, but they are subject to certain limitations and potential tax consequences. Rolling the funds into a Roth IRA may provide more flexibility and control over the assets for estate planning purposes.
- Flexibility: If your child decides not to pursue higher education or receives a scholarship, rolling over the unused funds to a Roth IRA allows you to repurpose the money for other financial goals.
- Tax Diversification: Having funds in both a 529 plan and a Roth IRA can provide tax diversification in retirement. This allows you to have a mix of taxable and tax-free income sources, giving you more control over your tax liability.
Considerations and Caveats
While the ability to roll over unused 529 plan funds to a Roth IRA may provide added flexibility and benefits, it’s important to be aware of the following considerations:
1. Tax Implications
While the rollover itself will not incur taxes or penalties, it’s important to consider the potential tax implications of the unused funds. The funds that were contributed to the 529 plan may have been eligible for state tax deductions or credits, and rolling them into a Roth IRA may result in the loss of those benefits. Additionally, if the funds have significant earnings, rolling them into a Roth IRA may trigger a tax liability.
2. Eligibility and Contribution Limits
Not everyone is eligible to contribute to a Roth IRA due to income limitations. Additionally, Roth IRA contribution limits apply, so it’s important to consider whether the rollover would exceed those limits.
3. Qualified Education Expenses
While a Roth IRA offers greater flexibility for withdrawal purposes, it’s important to note that funds rolled over from a 529 plan cannot be used to pay for qualified education expenses without incurring taxes and penalties. If you anticipate needing the funds for education expenses, it may be more beneficial to keep them in a 529 plan.
4. Future Tax Law Changes
The tax code is subject to change, and future legislation could impact the rules surrounding the rollover of 529 plan funds to Roth IRAs. It’s important to stay informed and consult with a financial advisor or tax professional before making any decisions.
Hot Takeaway
The ability to roll over unused funds from a 529 plan to a Roth IRA starting in 2024 provides an additional option for account holders. This change offers greater flexibility, tax advantages, and potential estate planning benefits. However, it’s essential to weigh the potential tax implications, consider eligibility and contribution limits, and evaluate your individual financial goals before making any decisions. Consulting with a financial advisor can help you navigate the complexities and make informed choices.
Now that you’ve learned more about this subject, feel free to read this recent news article on the topic: New change to 529 college savings plans has ‘so many caveats,’ advisor says. Here’s what to know
