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529 Plans are beneficial for education savings because they offer tax advantages and potential for significant growth. However, some people hesitate because the tax-free use of a 529 Fund is generally limited to education expenses. What happens if the child doesn’t go to college or if there is an excess of savings in the plan?  This uncertainty often deters parents from taking advantage of 529 Plans. However, recent changes in the rules address this concern and make these plans even more attractive.

Rollover Excess Funds to a Roth IRA

Many parents have leftover assets in a 529 Plan after their child has completed their education and they are unsure how to use it without incurring taxes and penalties. The Secure 2.0 Act, passed in 2022, offers a solution by allowing the rollover of excess funds from a 529 plan to a Roth IRA for the beneficiary child. This change provides a tax-efficient way to repurpose the funds, but there are several important restrictions.

Key Rules to Follow

• Duration of Maintenance: The 529 plan must have been maintained for at least 15 years. This rule ensures that the account has been used for its intended long-term educational savings purpose.
• Contribution Limits: Yearly rollovers to a Roth IRA cannot exceed the IRA contribution limit for that year. For instance, if the annual IRA contribution limit is $7,000, then you can only roll over up to $7,000 that year. This helps maintain the tax-advantaged nature of the IRA.
• Age of Funds: The funds being rolled over must have been in the 529 plan for at least 5 years. This rule aligns with the long-term savings intent of the 529 plan, ensuring that the funds were genuinely saved for educational purposes.
• Lifetime Rollover Limit: There is a cap of $35,000 on the total amount that can be rolled over from a 529 plan to a Roth IRA in a person's lifetime. This limit prevents excessive use of the rollover option and maintains the integrity of the tax benefits.

Example Scenario

Imagine it's 2023, and you have a 529 plan with $35,000 left over. Your parents set up the plan 30 years ago, your education has been fully paid for, and no new contributions have been made in the last 12 years.

You decide to roll over the leftover funds to a Roth IRA. Here's how you comply with the key rules:

• 15-Year Rule: The plan has been maintained for over 15 years.
• 5-Year Rule: The funds have been in the account for more than 5 years.
• Contribution Limit: The IRA contribution limit for 2023 is $6,500, so you roll over $6,500 this year.
• Lifetime Limit: You can continue rolling over funds annually until you reach the $35,000 lifetime limit.

By rolling over $6,500 each year within the IRA contribution limits, you avoid taxes and penalties. This strategy allows you to repurpose the excess 529 funds effectively, ensuring they continue to grow tax-free in a Roth IRA.

After making the initial rollover, you can continue to fund the Roth IRA within the annual contribution limits. This allows you to take advantage of the tax-free growth potential of the Roth IRA. Over time, this strategy can help you maximize the value of your savings and ensure that excess funds in your 529 plan are put to good use.

What if, after a $35,000 rollover, there is still excess?

For some diligent savers, the excess 529 Plan assets may exceed the $35,000 lifetime limit for rollovers to a Roth IRA. For parents with multiple children, the 529 Plan rules allow excess 529 Plan assets to be transferred to another eligible beneficiary, such as another child that has additional education expenses. A Roth IRA rollover would also be available for the new designated beneficiary, subject to the same rules and lifetime limit set out above.

If, after a parent follows this process to pay for education and fund rollovers to Roth IRAs for all of their children, there are still excess funds, it may make sense to retain the account and invest it with a future generation in mind. Grandparent 529 Plans are increasing in popularity due to a recent rule change.  Under the FAFSA Simplification Act, which amended the rules associated with the Free Application for Federal Student Aid (“FAFSA”), the number of questions asked of families was cut in half. These new rules changed how Grandparent 529 assets are considered on the FAFSA. Now, neither the value of Grandparent 529 Plan assets nor the amount of any distributions from a Grandparent 529 Plan are reportable on the FAFSA. While these rules may change as time goes on, right now, Grandparent 529 Plans are a great generational planning tool.

In summary, recent changes in the law have made 529 Plans more flexible and attractive. By understanding and following the key rules, you can effectively manage any excess funds in a 529 plan and continue to grow your savings in a tax-advantaged manner for your children and perhaps subsequent generations.