We’re approaching the first anniversary of the SECURE Act 2.0 which brought big opportunities in educational savings. In this article, we’ll explore two powerful tools for educational and retirement planning needs: 529 plans and Roth IRAs. We’ll unpack the pros and cons of each, helping you make informed choices for your savings journey.
529 Plans: Making Education More Affordable
Recognizing the challenge families face in saving for higher education, states have been offering programs to ease this burden since 1986. That year, Michigan launched a pre-paid tuition program through the Michigan Education Trust. About 10 years later, Congress passed legislation allowing states to establish qualified tuition programs under Section 529 of the IRS code. “529 Plans,” now part of the Small Business Job Protection Act of 1996, have evolved ever since. Currently, 49 states offer a 529 Plan.
Over the years, policymakers added benefits to 529 plans including the use of funds, tax-free, for:
- Qualified higher educational expenses including tuition, room, and board.
- K-12 public, private and religious school tuition (up to $10,000 per year per child) in addition to higher education costs.
- Payment of up to $10,000 of student loans per child, although each state has its own rules related to whether this is a qualified use of funds, so check the rules of the state your plan is in.
- Rollovers from 529 plans to ABLE accounts, up to the annual gift tax exemption less contributions already made in the current tax year, for certain beneficiaries.
529 Plans: Main Challenge
But what if, after growing a 529 account for years, you don’t need the funds for your child’s education? Perhaps your child receives other financial aid or decides not to go to school. You can change the beneficiary of the account to someone in a class of eligible family members so they can use it for educational expenses. But this option doesn’t allow you to benefit your child.
The SECURE ACT 2.0, passed last December, added a powerful new benefit to address that problem—the ability to rollover funds from 529 accounts to ROTH IRAs.
Now, if a 529 plan has been in existence for at least 15 years, you can rollover up to the annual ROTH IRA annual contribution limit to a ROTH IRA for the same beneficiary. Total lifetime rollovers cannot exceed $35,000.
ROTH IRA: Savings for Multiple Goals
ROTH IRAs are individual retirement accounts that offer many benefits beyond retirement savings. Here are some of the many benefits of a ROTH IRA:
- Like all retirement savings accounts, ROTH IRAs offer tax-deferred growth for assets within the account.
- While contributions to ROTH IRAs are not tax-deductible in the year they are made, withdrawals from the account are tax-free after the age of 59 ½. This means that any growth in the account over the years won’t be subject to income tax. Also, you can access any contributions you made penalty-free at any age.
- ROTH IRA funds can be used at any age for specific goals. It can be used for home purchase up to $10,000 if the IRA owner or spouse has not owned a home in the previous 2 years. Funds may be used toward the costs of higher education for yourself or certain family members. Money in your ROTH IRA can help you afford the birth or legal adoption of a child (up to $5,000).
- And, you never have to access funds in your ROTH IRA if you don’t need them. You can leave the entire account to your beneficiaries.
Typically, you can only contribute to a ROTH IRA up to the annual limits if you have earned income for that year, and your ability to contribute directly to a ROTH IRA is phased out above certain income levels.
New Opportunities: 529 Plan to ROTH IRA Rollovers
The 529 to ROTH IRA rollover strategy can be a powerful long-term financial strategy for several reasons:
- Anyone can contribute any amount to a 529 plan regardless of income level. Note that a contribution to a 529 for another person is considered a completed gift and subject to federal gift tax rules.
- Beneficiary can use funds for educational needs tax-free and penalty-free as needed.
- When the beneficiary completes their education, if the 529 plan has been in existence for at least 15 years, any remaining funds can be rolled into a ROTH IRA for their benefit. The annual amount rolled over is subject to the ROTH IRA contribution limit for that year. Lifetime rollovers cannot exceed $35,000.
- Any additional 529 funds can be rolled over into a qualifying family member’s 529 account.
Combining the benefits of 529 Plans and ROTH IRAs can be a powerful tool for future wealth creation. Of course, financial strategy is unique to each family situation. Consult with a financial professional before implementing such a specific strategy. At Copper Seed, we’re dedicated to helping you navigate your financial journey. Reach out to learn more about educational savings strategies.