529 EDUCATION PLAN CHANGES IN 2024:
Money put into a 529 grows tax-free at federal and state levels. There is no federal tax advantage for the contributions, but some states do offer tax breaks. When the money is withdrawn to pay qualifying college costs, the withdrawal is tax-free.
What happens if the youngster for whom the 529 plan was opened decides not to go to college or graduates before the funds are used in full? Under current tax law, if you do not use the funds for education and instead withdraw them for another reason, tax is paid on the amount, as well as a 10 percent penalty.
The only way to avoid the withdrawal penalty is to transfer the account balance to another student (the account beneficiary) within the family. This could be a sibling or even a parent who would use the 529 money for their education expenses.
Under the SECURE Act 2.0 another option becomes available in 2024. In certain cases, some 529 amounts can be converted/transferred into a Roth IRA without any tax or penalty.
Here are six things the Internal Revenue Service will be looking at next year if you want to move some 529 money into a Roth IRA:
- The option does not apply to new 529 plans. Lawmakers did not want taxpayers opening up 529 plans just to use them as Roth conversion vehicles. The reason for the change is to allow 529 plan account holders to apply leftover funds toward retirement. The new law says that eligible 529-to-Roth moves are available only for a 529 plan that's been open for at least 15 years.
- Contributions to the 529 plan within five years of a rollover are ineligible.
- The beneficiary of both the 529 account and the Roth IRA must be the same person. Joe Jr.'s educational savings money cannot be transferred to Joe Sr.'s retirement. This option was created to jumpstart a child's tax-advantaged retirement nest egg using the youngster's leftover tax-free education funds.
- Contributions to an IRA (Roth or traditional) are only allowed if the IRA owner has earned income. This also applies to the new SECURE 2.0 transfer opportunity. The child for whom the 529 was created must have earned income in order for the money to be rolled into that young person's Roth IRA.
Therefore, if a college graduate has $20,000 left in a 529 plan, but the young person focused only on lessons and did not work outside classes to earn money during the tax year, then none of the 529 funds can be transferred to a Roth retirement for that year.
- The annual transfer limit equals the IRA contribution limit for the beneficiary. If this was available in 2023, up to $6,500 — or the amount of money the beneficiary earned — can be transferred into a Roth (or traditional) IRA. The maximum allowable transfer for next year will be the contribution limit announced for 2024.
- Finally, there is also a lifetime maximum 529-to-Roth transfer of $35,000 per beneficiary.