Introduction

Imagine you’ve been saving for your child’s college education for years, diligently contributing to a 529 plan. You’ve watched the balance grow, comforted by the thought of helping to ease the financial burden of going to college. Now, fast forward to the day when your child is carving out a path for their future. They announce college is not the right path for them. What now? At this point, you might feel a sense of dread, thinking about the potential penalties and taxes you’ll face when withdrawing the funds for non-educational purposes. Fear not because the recent Secure Act 2.0 brings a silver lining to this scenario.

With this legislation, your meticulously saved 529 funds can be converted into a Roth IRA if not used for qualifying educational expenses. This is a game-changer for parents and guardians previously limited by the stringent rules of 529 plans. Let’s take a deeper dive into how you can use these changes to your advantage.

Understanding 529 Plans and Roth IRAs

First, let’s get on the same page about what 529 Plans and Roth IRAs are. A 529 Plan is a tax-advantaged savings plan designed to encourage saving for future education costs. The funds in these accounts can be used for a wide range of educational expenses, from tuition fees to textbooks.

On the other hand, a Roth IRA (Individual Retirement Account) is a retirement account where you fund the account with already taxed money. All future investment results and withdrawals are tax-free. This becomes particularly beneficial for younger adults as it provides tax-exempt investment growth and- a tax-free income source in retirement.

The Secure Act 2.0 has bridged the gap between these two financial instruments, allowing the partial conversion of the remaining 529 funds into a Roth IRA. This means that money initially set aside for education can now be repurposed for retirement without the burden of penalties or additional taxes.

How to Qualify

A few circumstances must be met for your 529 plan funds to qualify for this provision:

1. The 529 Plan must have been around for at least 15 years.
2. Beneficiaries can roll over up to a maximum of $35,000 for their lifetime.
3. The amount being rolled over has been held in the account for at least 5 years.
4. The beneficiary must have earned income up to the amount you plan to convert to a Roth IRA.
5. IRA annual contribution limits apply (currently limited to $6,500/year in 2023 for individuals under age 50).

While these rules might seem straightforward, there are still some gray areas to navigate. For instance, the IRS hasn’t yet clarified how income limitations with Roth IRAs affect conversions from 529s to Roth accounts.

Maximizing the Benefits of Secure Act 2.0

Now that we understand the basics let’s talk about how to make the most of this change. One of the first things you could do is reassess your financial strategy. If you have been contributing to a 529 plan with the sole purpose of funding education, you may want to reconsider your approach. With the flexibility to convert these funds into a Roth IRA, it might make sense to increase your contributions, essentially padding your child’s retirement savings. If you have been considering a 529 plan for your child’s education costs, this provision may encourage you to open the account today so the 15-year clock starts.

Lastly, remember this change does not eliminate the primary purpose of 529 plans. They are still primarily meant for education savings. The conversion to a Roth IRA is only an option if the funds are not used for qualified educational expenses. Therefore, it’s wise to balance the dual potential of these plans, keeping in line with your long-term financial goals.

Wrapping It Up

Effective January 1, 2024, the passage of Secure Act 2.0 has significantly changed the landscape of college savings accounts. Allowing 529 funds to be converted to Roth IRAs has added an extra layer of flexibility to these plans. This change is a powerful tool for individuals and families, enabling them to adapt their financial strategies to meet changing circumstances.

The changes brought about by Secure Act 2.0 offer exciting possibilities, but financial decisions aren’t made in a vacuum. They should be viewed in the context of your whole financial picture. If you have questions or would like more information, consider reaching out to your financial advisor. We love answering questions and we’re always here to help.

With the right approach and strategy, the changes to college savings accounts can significantly boost your child’s financial stability, both for education and retirement. Here’s to a future filled with financial security and peace of mind!

Any opinions are those of the authors and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Expressions of opinion are as of this date and are subject to change without notice.