How new 529 plan rules can help with retirement planning

Every year, investors use 529 plans to save for their loved ones’ educations. While this tax-advantaged account has many benefits, one concern has long persisted with parents, grandparents and others: If college plans change, excess 529 plan funds could go unused or be subject to a tax penalty if used for nonqualified education expenses.

A recent change to U.S. law provides more flexibility for 529 plan assets. Starting in 2024, 529 account owners will have the option to use excess 529 plan funds to jumpstart the retirement of their beneficiaries.

Here’s what you need to know about this change:

How does the new law change affect excess 529 plan funds?

In December 2022, SECURE Act 2.0 was signed into law to enhance retirement savings opportunities for Americans. One provision will allow owners of a 529 plan to move unused funds in the account directly to the plan beneficiary’s Roth IRA.

This option, which will take effect in 2024, may provide beneficiaries with tax-free retirement money. Up until the law is in effect, if beneficiaries use assets in a 529 plan for anything other than qualified educational expenses, the earnings portion of any nonqualified distribution is likely subject to ordinary income taxes and a 10% penalty.

What special considerations and limitations should I be aware of?

  • 529 plans must be 15 years old: 529 accounts must have been maintained for a minimum of 15 years to be eligible for transfer.
  • This would benefit the beneficiary, not the 529 account holders. The funds from the 529 plan must be moved directly to a Roth IRA of the 529 plan beneficiary.
  • Lifetime maximum: The 529 transfer is subject to a lifetime maximum of $35,000 from a 529 plan account to a Roth IRA.
  • Roth IRA contribution limits still apply. For 2023, those limits are $6,500 per year if the beneficiary is under 50 and $7,500 per year for those over 50. These limits are subject to change every year.
  • Roth IRA income limits don’t apply but earned income requirements do. The Roth IRA income thresholds will not apply to these contributions; however, the beneficiary will need to have earned income equal to or more than the contribution in order to move 529 funds into the Roth.
  • There are still unknowns: SECURE Act 2.0 is still new, and we expect lawmakers to share more detailed guidelines prior to when the law goes into effect in 2024. Individual states may also have their own stipulations regarding rolling over excess 529 plan funds to a Roth IRA.

I’m an account owner of a 529 plan. Can I change the name of the beneficiary to myself to benefit from this new provision?

If you created a 529 account for a loved one and have excess funds in the account, you could technically change the beneficiary to yourself, but based on the language in SECURE Act 2.0, this may likely reset the 15-year clock. This means you would need to wait 15 years before you could transfer any 529 plan funds into your Roth IRA.  

Government agencies still need to confirm whether the clock will be restarted or not, so there may be unforeseen consequences of initiating a beneficiary change.

How can my family take advantage of this change?

Parents and grandparents can feel more confident about opening and funding a 529 account. Now, if a student decides to pursue a less expensive educational path or receives more merit scholarships, those 529 plan funds will still be earmarked for their future — albeit in a different way.

This change also presents a unique estate planning opportunity for individuals wanting to make an impact with their legacy. As such, parents and grandparents may want to consider increasing their 529 plan contributions, or opening an account for their loved ones, now that excess 529 plan funds can give beneficiaries a head start on retirement savings.

What are the tax implications of this new change?

The transfer of unused 529 plan assets will not trigger any federal taxable event. However, adoption of these new tax provisions may vary from state-to-state. If a state chooses not to conform, then the transfer potentially may be subject to state income tax.

The most significant tax implications are positive for the beneficiary. Instead of paying taxes on unused 529 assets and incurring the 10% penalty when withdrawn for nonqualified expenses, a beneficiary can move their 529 plan funds to a Roth IRA where they grow tax-free.

Make the most of the new rules for 529 plans

Until recently, many parents and grandparents have been careful to not overfund 529 accounts. Now, beginning in 2024, families and others have more flexibility with these assets and can give their beneficiaries the opportunity to start saving for retirement early.

We can help you talk through the 529 plan rule change and help you identify tax-efficient strategies to save for a loved one’s education and beyond.