Ep. 245 – 529 Plans to Roth IRA – How it Works in Retirement

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In this Episode of the Secure Your Retirement Podcast, Radon and Murs discuss the 529 plan as a tax-free investment vehicle and the new ruling around it. A 529 plan is a tax-free compound interest account funded for qualified educational expenses.

Listen in to learn about the stipulations around the new ruling enabling rolling unused 529 money into a Roth IRA for the beneficiary you set it up for. You will also learn the importance of opening and funding a 529 account without going crazy with the money and teaching your kids/grandkids how to open a Roth IRA account as early as they can.

In this episode, find out:

●     The power of the 529 plan as a tax-free compound interest account for qualified educational expenses.

●     The new ruling enables rolling unused 529 money into a Roth IRA for the beneficiary you set it up for.

●     The 15-year hoarding period of the 529 account before rolling it into a Roth IRA.

●     Why the 529 rollover is limited to the annual Roth IRA limit and a lifetime limit.

●     The 529 beneficiary must also be the owner of the Roth IRA and cannot be transferred to a different beneficiary.

●     The earned income amount rule for the 529 beneficiary to be able to roll over the annual Roth IRA limit.

●     Why you should open and fund a 529 account and teach your kids/grandkids how to open a Roth account.

Tweetable Quotes:

●     “With a 529, the rule is, all growth is tax-free provided it is used for qualified educational expenses.”– Murs Tariq

●     “There’s an ability to roll unused 529 money into a Roth IRA for the beneficiary that you set it up for.”– Murs Tariq

Resources:

If you are in or nearing retirement and you want to gain clarity on what questions you should be asking, learn what the biggest retirement myths are, and identify what you can do to achieve peace of mind for your retirement, get started today by requesting our complimentary video course, Four Steps to Secure Your Retirement!

To access the course, simply visit POMWealth.net/podcast.

Here’s the full transcript:

Radon Stancil:	Welcome to Secure Your Retirement podcast. Murs and I are excited today to talk with you about a topic that when we talk about it, most of the times it’s one of those proud moments that maybe a parent or grandparents thinking about their kid, their grandchild, their children going to college and they’re thinking, “Hey, I want to make sure that I can help them. And I’m thinking about doing this thing called a 529 plan.”
	Now, most of you might be familiar with that, but I think it’d be good for us to have a nice little overview. Just a real brief one here, and I’m just going to let Murs answer questions here. So Murs, could you give us a nice little overview of what a 529 plan is and why it could be of benefit?
Murs Tariq:	Yeah, I’ve become a bit of a resident expert on the 529 just because I did a lot of research on different ways to save for college for my kid when he was born back in 2020. So now he’s almost four years old and I ended up going with the 529 plan for him. So what it is is it’s a college savings account, and actually, it can be used… It’s known as a college savings account, but it can actually be used for, say, private school or something like that as well. But what you do is you fund this account, and then when you actually need to use the money for qualified educational expenses, those withdrawals become tax-free.
	Well, what’s advantageous about that?
	Well, it’s an investment account, it’s a big piece of it. So just think about if you put it away… You’ve probably heard or read all the different articles about the power of money growing on top of money.
	I can’t think of the term right this second.
Radon Stancil:	[inaudible 00:02:15].
Murs Tariq:	Compound interest, right? Compound interest, money growing on money. If you start early enough, put in $100 a month, that can really start to snowball if it’s invested and in the market. And the key here is it’s got time to grow. So if someone is just born and you open an account for them $100 a month doesn’t sound like much, but over 18 years before they start even considering college, plus maybe a 5, 6, 7, 8, 9, 10% return on top of that, that money can be considerable. Now, in a normal investment account, anytime you would use that money, typically you’re going to have to deal with capital gains. But with a 529, the nice rule here is that all growth is tax-free, provided that it is used for qualified educational expenses, so there is some power to that.
	So like Radon said, I’ve set one up for my son, but what’s nice is his grandparents, my parents and my in-laws every year will write a check to deposit to that. So one question we get all the time from clients is, “Hey, should I set this one up myself for my grandchild, or should I let their parents set it up, and then just contribute to it?”
	The answer is it’s kind of whichever you want to do from a convenience perspective, it may just be easier to have one 529 and just contribute to it, and let the parents kind of manage that one and the grandparents contribute to it, and write a check to it yearly or whatever. But if you want to be the owner of that account, then yeah, you could set it up on your own as well and contribute to it. So that part’s very flexible.
	And there’s a lot of things to understand about a 529. The purpose of this podcast episode really is to talk a little bit more about some of the new ruling that has come out that become effective in 2024, but the big concept here is you can fund an education account for a beneficiary, and it’s going to get tax-free growth treatment to use down the road for college expenses, room, board, tuition, all those things like that, so it can be pretty powerful, especially in a world where education and college is becoming incredibly expensive.
Radon Stancil:	And the nice thing is, too, if I leave it to my child, and let’s say one doesn’t go to school and the other one does, then you can transfer it to another beneficiary. So you do have some flexibility there, but just remember, if nobody went to school, and the money comes out, then I lose that tax-deferred growth. I don’t get that tax-free growth there because it wasn’t used for school. So that’s just one of those things you have to kind of look at and say, “Well, maybe I’m going to diversify and have some money there, especially if I’ve got multiple beneficiaries.”
	But Murs, you brought up this idea of some of the new rules. Starting in 2024, you’re able to actually do some extra stuff with the 529. Can you walk us through what that looks like?
Murs Tariq:	Yeah, so going back to what you said, before this new ruling came out, it was something that you had to be careful about. So the way I was setting up the 529, and by the way, this whole episode kind of spurred off of a conversation that I had with a client of ours, and she had questions around a 529, and how much should I fund, and everything like that, prior to this new ruling, you did have to worry about how much you’re going to fund because the worry is, well, what if the kid doesn’t go to college? Or what if they only go to a two-year school, but you saved enough for a four-year school and there’s no beneficiary to transfer it to? The money in there now, to take it out for non-educational expenses is going to get penalized and taxed. So you want to be careful about how much you fund.
	What’s made that decision easier now is the new ruling that there’s an ability to roll unused 529 money into a Roth IRA for the beneficiary that you set it up for. So you can see, now, it eases that pressure of making the decision on, “Well, I’m so worried about overfunding this. What if they don’t go to school?”
	Well, you can. They’ve given us a bit of an out now that was never there of, if they don’t use it or they don’t use all of it or don’t go to school, whatever, you are now allowed to roll a certain amount of that to a Roth IRA for that beneficiary. So before you start saying, “Now I’m going to… I love this. Let me put hundreds of thousand dollars into this account so that I can do this kind of crazy backdoor Roth type of strategy for my kid,” there are stipulations to it, right? It’s not an unlimited amount, and there are rules around how you get the money into the Roth, and that’s what I wanted to talk about today, because it sounds really good on the surface, but you have to understand the rules.
	And when I talked to the client about this as well, she was like, “Oh, I didn’t know it was going to be that difficult. It’s still good, but it’s something that is good to really get clarity on.” And it is a relatively new ruling as well, so I think there’ll be more clarity that comes out of it, but there’s three major things that we want to be thinking about. And let’s just go ahead with the scenario of you have a $100,000 529, the kid is 18, they’re going to school, but they don’t end up using all of it. And there’s money leftover. Previously, to get that money out, you’d be paying a penalty.
	Now we can move that leftover money into a Roth IRA for that child. But how do you do that? What are the rules? What are the limits? The first thing you got to understand is that you can’t just do this today and then roll it tomorrow. There is a holding period that you have to have had the 529 account for at least 15 years before you can do the rollover. So they’re thinking long-term here. They don’t want people just opening 529s for the purpose of the Roth rollover, they want it to be 529 first for the purpose of education funding. And then, yeah, if there is money left over, we’re now giving you an out, but it has to be held for 15 years in the 529 to even be eligible to talk about rolling it into a Roth account. So that’s number one, the holding period.
	Number two is the annual limit. And the annual limit is whatever the IRS says the annual limit for an IRA or Roth contribution is. So this year in 2024, it’s so fresh. I know 2023 was 6,500. For this example, let’s just assume it’s 6,500 in 2024 as well. And so you’re capped as to how much you can put in to whatever the annual limit is. So right now it’s 6,500 in this example. So say you got 40,000 in the 529, you can only put, of that 40,000, 6,500 per year into now the Roth IRA for the beneficiary.
	The other piece of this that you have to realize is that they have put a cap. So there’s an annual cap as well as a lifetime cap amount that can roll into the Roth IRA. So 6,500 is the annual, and the most you can roll from a 529 to a Roth IRA is 35,000 over lifetime basically. So you’re capped as to how much you can put in. Again, this isn’t supposed to be some magical retirement strategy. It’s designed to be an out from overfunding a 529 account.
	And then the last is ownership. Who gets it? The beneficiary of the 529 must also be the owner of the Roth IRA. You can’t have leftover money and then switch it to someone else, and then put that into a Roth IRA. I think there’s going to be more clarification that comes out on that rule, but just assume and understand that if it was a 529 for Bob, it needs to roll into a Roth IRA for Bob.
	One thing I want to go back on is, as well, so there’s this thing called earned income. And in order to fund an IRA or a Roth IRA, the IRS says you have to have this thing called earned income. Earned income, just think of it as wages or a salary. You have to have as much earned income as you want to contribute to a Roth IRA or a traditional IRA. That rule also applies to that 6,500 annual limit. So in order for the child to be able to roll 6,500 a year from the 529 into their own Roth IRA, they also have to have the earned income amount to be eligible for that contribution as well. So you can tell here it gets a little complex, a little confusing very quickly, and so I just wanted to bring it to light because I just had a recent conversation with a client around it. It’s still a good thing, but there are nuances that we really need to understand.
Radon Stancil:	Yeah, just to give this a high level, I think this is good just to say, “Hey, I didn’t maybe use everything,” but remember contextually here, if I’ve got to hold it for at least 15 years, I don’t have a little child, right? I’ve got a kid who’s probably went to school, maybe didn’t use it all, so they’re now maybe even close to 20 years old or older, so they’re probably going to work and we don’t have to worry about this whole, “Am I making enough money?” It is likely that these caps are going to be indexed and rise, okay? So the 6,500, as Murs said, is higher this year in 2024. So very likely the $35,000 cap is going to go up as well.
	So we don’t know all the details. This is just a brand new rule starting here in 2024. So what are some things you could do? Well, number one, if you have a 529, you can fund it. I always say do that, and again, in an approach that says, “I might have a child who doesn’t go to school.” Or they get some scholarship and they don’t need all the money. So don’t, in my opinion, go crazy with a 529, but fund it. And then if you’ve got it there, and then you know that you can utilize it the other way.
	The other thing is teach your child or grandchild to open a Roth as soon as they can open a Roth. Now, by the way, I could have a young teenage child working part-time anywhere, and as long as they have earned income, they can open a Roth IRA and start funding it. There’s many advantages to it because it’s open. A Roth IRA lets them put the money in there and grow it tax-free. It’s a great way for a great tool.
	Then make sure that… Murs talked about, “Well, there’s a little wacky rule in there. I can’t…” Remember how I said in the beginning we could change beneficiaries from one to the other? Well, the rule’s not clear yet how that’s going to work on that. It could trigger a whole new 15 year holding period. So you really want to open a 529 for the beneficiaries that you… So you’ve got three grandchildren, open three 529 plans. And just realize that this could be a caveat that we could utilize. So it’s brand new, now that it’s an option, this might give you a little bit of confidence to go ahead and open a 529 and start funding it. We’ve got some clients putting $100 a month into it. They’re not going crazy, but they got it opened.
	The next moral of the story is, talk to your kids, grandkids, about opening a Roth IRA, great tool.
	And then if you have any questions about this, about how to do this, we are glad to help you. Just so you know, 529 plans are heavily regulated as far as their investment structure and all that kind of stuff, so this is not anything that we even make any money on whatsoever. It is a complete service to help our clients help their kids and grandkids. So anyway, if you have any questions on that, feel free to reach out to us. You can go to our website, top right-hand corner, click on Schedule a Call. We’re glad to hop on a call and talk to you about a 529 plan, Roth plan, whatever you might need. Hope you have a great week, we’ll talk to you again next Monday.