Thank you, SECURE 2.0, for 529-to-Roth IRA rollovers

While the legislation provides an attractive option for families who end up not needing the money in a 529 plan, it's not clear how many will be eligible to use it.

Saving for education in a 529 plan can provide significant tax advantages. But many misconceptions prevent families from taking advantage of this powerful savings vehicle. The SECURE 2.0 Act eliminates one of the most prevalent objections: “If you save in a 529 plan, your money is trapped.” Families can be hesitant to put their savings into a vehicle that they believe is specifically designated for an expense they aren’t sure they even face.

529 plans are beneficial for much more than your typical four-year schools. They’re also a great savings vehicle for eligible community colleges, vocational and trade schools, certain K-12 expenses and more. This flexibility is ideal for saving early, as it’s hard to look at a baby and know for sure what their future education needs and wants will be.

Although 529 plans are subject to some distribution restrictions, if your client’s child doesn’t need 529 savings for higher education — or if the client needs to access the money to cover an unexpected expense — there are still options. And it’s important to know that none of them sacrifice their hard-earned and carefully saved principal (what the client contributed). 529 plans allow individuals to:

transfer the money to a sibling to use for their post-secondary education;
use it yourself for continuing education or career retraining;
use it to pay off a student loan, up to $10,000; or
withdraw the money and pay tax and a 10% penalty on just the earnings portion of your savings; your principal will never be taxed or penalized.

The 10% penalty may not even apply if the beneficiary:

decides to attend a U.S. military academy;
receives a scholarship (for withdrawals up to the scholarship amount); or
becomes disabled or dies.

SECURE 2.0 introduces another attractive option for families: They can roll a beneficiary’s unused 529 balance into a Roth individual retirement account, giving the beneficiary an early start on saving for retirement. Eligibility rules apply to these Roth IRA rollovers:

The 529 account must have been in existence for 15 or more years.
The funds to be rolled over must have been in the 529 account for at least five years.
The 529 plan beneficiary must have earned income (similar to the Roth IRA eligibility requirements) in the rollover year.
The rollover amount in any given year can’t exceed the beneficiary’s IRA contribution limit, reduced by any IRA contributions previously made for the year.
The total (lifetime) rollover amount is limited to $35,000.

[More: Can I use IRA to pay for college?]

While the ability to roll over into a Roth IRA is a compelling new benefit for prospective savers, it will be interesting to see how popular it is among existing savers when it becomes effective starting in 2024.

Early review of the 6.5 million 529 plan accounts Ascensus administers revealed that few accounts may be eligible to take advantage. Only 100,000 accounts had been open and funded for 15 years.

Interestingly, the average balance for these potentially eligible accounts is $38,000, just above the maximum rollover amount limit. However, nearly half had already taken a withdrawal, and with an average beneficiary age of 21, it’s a strong signal that they could be in the middle of paying for college and may not have funds to roll over upon completion.

This finding aligns with the fact that most savers do not save for the full amount of higher education. On average, accounts with beneficiaries ages 16 and 17 have balances that cover 41% of tuition, fees, and room and board at a four-year, in-state public university, and 19% of tuition, fees, and room and board at a four-year private university.

Even if there is a slow start to adoption, the inclusion of 529 plan-to-Roth IRA rollovers in SECURE 2.0 is absolutely a win. It further breaks down barriers to starting to save for education and could allow eligible savers a fantastic head start in their retirement savings.

[More: Game changer or not, SECURE 2.0 529 rollover rule turns advisor heads]

Peg Creonte is president of Ascensus Government Savings.