#173 - 529 to Roth: New Planning Opportunities
Starting in 2024, a transfer from a 529 plan to a Roth IRA will not be subject to penalty or income tax under certain conditions. This change in 529 rules presents a number of planning opportunities. Here is a quick overview:
Lifetime limit of $35,000
529 plan has to have been maintained for 15 years
Distribution can’t be from contributions or earnings on those contributions in the last 5 years
Distribution is subject to the annual IRA/Roth contribution limit. For example, if the annual limit is $6,500 and I have already done $3,000 directly then I may be able to do $3,500 that year from the 529.
The Roth IRA owner is still subject to the earned income requirement
First, let’s look at 529 owners who want to benefit the beneficiary with the funds. Let's assume you have been diligently saving for your daughter into a 529 plan since she was first born. Now she graduates from high school and chooses to develop a business she started instead of going to college. Instead of potentially having to pull the money out as an unqualified expense you may be able to slowly transfer the money into a Roth IRA for your daughter. The implication is that you may be able to supercharge your daughter's retirement savings. If the individual earns 8%, that supercharge could easily be worth more than $1,000,000 by the time they retire. Now, let’s look at someone who instead chooses to use the funds for their own retirement. The account owner may be able to change the beneficiary from the child to themselves and contribute to their own Roth. We don’t know yet if this would cause the 15yr clock to reset (additional guidance from IRS is needed). The interesting thing is these transfers would not be subject to the maximum modified AGI limits that normal Roth contributions are subject to. In other words, this may be another avenue to complete the “Backdoor Roth." This method of completing the Backdoor Roth actually has advantages over the normal method. For example, based on what we know now, the same IRA pro-rata rules wouldn't apply to the transfer. Another quick note is even though the Federal government is saying this is allowed tax and penalty-free, states may treat it differently. Indiana has a nonrefundable 20% state income tax credit on contributions to the 529 up to a limited amount. It would not shock me if they follow the Federal guidelines as far as not including the distribution in income but still require the tax credit to be repaid. Once again additional guidance is needed before we know. While there is still some clarification needed at both the federal and state level, at a minimum this should make parents more confident about putting money into a 529. Even if someone had very low confidence that their child was going to use the money for college but they wanted to benefit their child, the 529 may be a good option because while they may not be able to contribute to a Roth directly while their child has no earned income, they could start saving into a 529 and then transfer money into the Roth once it was appropriate and the stipulations were met.
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