How new 529 plan rules can help with retirement planning

Find out how a recent change to U.S. law provides more flexibility for 529 plan assets.

Every year, investors use 529 plans to save for their loved ones’ educations. While this tax-advantaged account has many benefits, one concern has long persisted with parents, grandparents and others: If college plans change, excess 529 plan funds could go unused or be subject to a tax penalty if used for nonqualified education expenses.

Beginning this year, that concern is addressed, thanks to a change in U.S. law. Starting in 2024, 529 plan owners now have the option to use excess 529 plan funds to jumpstart the retirement savings of their beneficiaries.

Please note: Although the change to 529 plans is effective for 2024, the Treasury Department has yet to issue guidance for providers on how to implement the provision, so its availability will likely vary among providers.

We will help you evaluate how this change can potentially benefit your family and loved ones.

Here’s what you need to know about this update to 529 plans:

How does the new law change affect excess 529 plan funds?

In December 2022, SECURE Act 2.0 was signed into law to enhance retirement savings opportunities for Americans. One provision — effective in 2024 — allows owners of a 529 plan to move unused funds in the account directly to the plan beneficiary’s Roth IRA.

This option may provide beneficiaries with tax-free retirement money. Previously, if beneficiaries were to use assets in a 529 plan for anything other than qualified educational expenses, the earnings portion of any nonqualified distribution would likely be subject to ordinary income taxes and a 10% penalty.

What special considerations and limitations should I be aware of?

529 plans must be 15 years old to be eligible for Roth transfer: The 529 plan must have been maintained for a minimum of 15 years to be eligible for transfer. Further, contributions made to the 529 plan in the five years before the start of distributions — including the associated earnings — are ineligible for a tax-free rollover.
This change benefits the beneficiary, not the 529 plan account holders. The funds from the 529 plan must be moved directly to a Roth IRA of the 529 plan beneficiary.
Lifetime maximum: The 529 transfer is subject to a lifetime maximum of $35,000 from a 529 plan account to a Roth IRA.
Roth IRA contribution limits still apply. For 2024, those limits are $7,000 per year if the beneficiary is under 50 and $8,000 per year for those 50 and over. These limits are subject to change every year.

Roth IRA income limits don’t apply but earned income requirements do. The Roth IRA income thresholds will not apply to these contributions; however, the beneficiary will need to have earned income equal to or more than the contribution to move 529 plan funds into the Roth.
There are still unknowns: SECURE Act 2.0 is still new, and we expect the Treasury Department to share more detailed guidelines. Individual states may also have their own stipulations regarding rolling over excess 529 plan funds to a Roth IRA. Due do the uncertainty with future guidance, it is unclear when providers will be able to offer the functionality.

I’m an account owner of a 529 plan. Can I update the name of the beneficiary to myself to benefit from this new provision?

If you created a 529 plan for a loved one and have excess funds in the account, you could technically change the beneficiary to yourself, but based on the language in SECURE Act 2.0, this may likely reset the 15-year clock. This means you would need to wait 15 years before you could transfer any 529 plan funds into your Roth IRA.

Government agencies still need to confirm whether the clock will be restarted or not, so there may be unforeseen consequences of initiating a beneficiary change.

How can my family take advantage of this change?

Parents and grandparents can feel more confident about opening and funding a 529 plan. Now, if a student decides to pursue a less expensive educational path or receives more merit scholarships, those 529 plan funds can still be earmarked for their future — albeit in a different way.

This change also presents a unique estate planning opportunity for individuals wanting to make an impact with their legacy. As such, parents and grandparents may choose to increase their 529 plan contributions, or open an account for their loved ones, now that excess 529 plan funds can give beneficiaries a head start on retirement savings.

What are the tax implications of this change?

The transfer of unused 529 plan assets will not trigger any federal taxable event. However, adoption of these new tax provisions may vary from state to state. If a state chooses not to conform, then the transfer potentially may be subject to state income tax.

The most significant tax implications are positive for the beneficiary. Instead of paying taxes on unused 529 assets and incurring the 10% penalty when withdrawn for nonqualified expenses, beneficiary can move their 529 plan funds to a Roth IRA where they grow tax-free if conditions are met.

Take advantage of new rules for 529 plans

Until recently, many parents and grandparents have been careful to not overfund their 529 plans. Now, families and others have more flexibility with these assets and can give their beneficiaries the opportunity to start saving for retirement early.

We will help you talk through the 529 plan rule change and help you identify tax-efficient strategies to save for a loved one’s education and beyond.