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Americans saving for college in 529 plans will soon have a way to save unused funds while keeping their tax advantages intact.
A $1.7 trillion government funding package includes a provision that allows savers to withdraw money from 529 packages to Roth Individual Retirement Accounts Free of income tax or tax penalties.
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The House past the Friday measure and the Senate did it Thursday. The bill is headed for President Biden, who is expected to sign it.
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The rollover measure – which comes into effect in 2024 – has some limitations. Among the most important: there is a lifetime cap of $35,000 on transfers.
It’s a good layout for people who have it [529 accounts] and the money was not used,” said Ed Slott, a chartered accountant and IRA expert based in Rockville Center, New York.
This may occur if a beneficiary – such as a child or grandchild – is not attending a college, university, K-12 vocational or private school, or other qualification establishment, for example. Or, a student can receive scholarships this means that there are approximately 529 funds remaining.
Millions of 529 accounts hold billions in savings
There were nearly 15 million 529 accounts at the end of last year, holding a total of $480 billion, according to at the Institute of Investment Companies. That’s an average of around $30,600 per account.
529 plans to provide tax benefits to college savers. Namely, investment earnings on account contributions grow tax-free and not taxable if used for eligible education expenses such as tuition, fees, books, room and board.
However, this investment growth is generally subject to income tax and a 10% tax penalty if used for an ineligible expense.
This is where transfers to a Roth IRA can benefit savers with locked-in 529 money. A transfer would circumvent income tax and penalties; Investments would continue to grow tax-free in a Roth account, and future retirement withdrawals would also be tax-free.
Some think it’s a handout for the rich
However, some critics believe the rollover policy largely amounts to tax relief for wealthy families.
“You give savings incentives to those who can save and leave behind those who can’t,” said Steve Rosenthal, senior fellow at the Urban-Brookings Tax Policy Center.
A 2012 analysis conducted by the Government Accountability Office found that the typical American with a 529 account had “significantly more wealth” than someone without: $413,500 in total wealth for the median person, about 25 times the amount of a no -account holder.
You offer savings incentives to those who can save and you leave out those who cannot.
Steve Rosenthal
senior fellow at the Urban-Brookings Tax Policy Center
Additionally, the typical homeowner had an annual income of about $142,000 compared to $45,000 for other families, according to the GAO report. Almost half, 47%, had incomes over $150,000.
The new Roth IRA 529 transfer provision has no income limits.
Limitations on 529 Transfers to IRAs
While the new tax relief primarily benefits wealthy families, there are “pretty significant” limitations on rollovers that reduce the financial benefit, Jeffrey Levine, a St. Louis-based certified financial planner and certified public accountant, said in a Tweeter.
Restrictions include:
- A lifetime limit of $35,000 on transfers.
- The bearings are subject to the annual Roth IRA contribution limit. (The limit is $6,500 in 2023.)
- The rollover can only be done on the beneficiary’s Roth IRA, not the account holder’s. (In other words, a 529 owned by a parent with the child as beneficiary should go into the child’s IRA, not the parent’s.)
- The 529 account must have been open for at least 15 years. (It looks like changing account beneficiaries could restart that 15-year clock, Levine said.)
- Account holders cannot carry forward contributions or income from such contributions made within the last five years.
In a summary documentthe Senate Finance Committee said current 529 tax rules have “led to hesitation, delay, or denial of funding for 529 at the levels necessary to pay for rising education costs.”
“Families who sacrifice and save on 529 accounts should not be punished with taxes and penalties years later if the beneficiary found another way to pay for their education,” he said.
Are 529 plans already flexible enough?
Some education savings experts believe that 529 accounts provide enough flexibility that families should not be deterred from using them.
For example, owners with remaining account funds can change benefits to another eligible family member — thereby avoiding a tax penalty for ineligible withdrawals. Aside from a child or grandchild, that family member could be you; spouse; a son, a daughter, a brother, a sister, a father or a mother-in-law; brother or half-brother; first cousin or spouse; a niece, nephew or their spouse; or aunt and uncle, among others.
Owners can also keep funds in an account for a beneficiary’s higher education or the education of a future grandchild, according to at Savingforcollege.com. Funds can also be used to make up to $10,000 in student loan repayments.
The tax penalty may not be as severe as some people think. according to to education expert Mark Kantrowitz. For example, taxes are assessed at the recipient’s income tax rate, which is typically lower than the parent’s tax rate by at least 10 percentage points.
In this case, the parent “is no worse off than they would have been had they saved in a taxable account”, depending on their tax rate on long-term capital gainshe said.
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