Author: Mary Miles
A 529 plan is a tax advantage savings plan designed to help pay for education as governed by Section 529 of the Internal Revenue Code. Typical investors are parents who designate their children as beneficiaries of the 529 accounts. The 529 plans grow tax-deferred, and withdrawals are tax-free and penalty-free if used to cover qualified higher education expenses as defined under 26 U.S.C.S § 529(e)(3). These expenses include but are not limited to tuition, fees, books, supplies, and equipment the beneficiary needs to attend college, as well as room and board. Id.
The SECURE Act 2.0 of 2022 (the “Act”) was passed on December 23, 2022. Section 126 of the Act amends the Internal Revenue Code to allow beneficiaries of 529 College Savings Plans to roll over up to $35,000 of unused funds throughout their lifetime from any 529 accounts in their name to their Roth IRA tax and penalty-free.
This change is meant to incentivize the use of 529 college savings plans by minimizing concerns over the penalties imposed on non-qualified withdrawals (withdrawals of funds for expenses not qualified under 26 U.S.C.S § 529(e)(3)). Non-qualified withdrawals are subject to state and federal income taxes and a 10% penalty on the earnings portion of the withdrawal. 26 U.S.C.S § 529(c)(6). The 529 funds become “stranded” when a beneficiary does not attend college, drops out of college, or has leftover 529 funds. The funds become inaccessible or “stranded” for parents who do not want to incur income taxes and penalties on non-qualified withdrawals. These concerns have made parents less likely to invest in 529 plans.
The new rule attempts to combat these concerns by allowing 529 beneficiaries to roll over unused funds to Roth IRAs to grow earnings and become accessible to the beneficiary in retirement. However, the new rule limits the amount and frequency of rollover contributions and limits the 529 accounts that are eligible for rollover.
Specifically, Section 126 of the Act amends paragraph 3 of Section 529(c) of the Internal Revenue Code by adding subsection (E) titled “Special Rollover to Roth IRAs from Long Term-Qualified Tuition MEMORANDUM Programs” and contains the following limitations under §126(a) of the Act [ will be cited as 26 U.S.C.S . §529(c)(3)(E)(i)-(ii) once effective]:
Pursuant to § 126(d) of the Act, the amendment will become effective after December 31, 2023.
Although the Act may alleviate some investor concerns regarding “stranded” 529 funds, it is unclear how the Act will interpret changes in a 529 beneficiary for purposes of a rollover. Consider a scenario where a parent sets up a 529 account for her child who does not attend college. Instead of rolling over the unused 529 funds to a Roth IRA to benefit her child, the parent wishes to roll over the unused funds to a Roth IRA in her name and changes the 529 beneficiaries to herself (§529(c)(3)(C)(ii) allows a 529 beneficiary to be changed without tax consequences or penalties when the new beneficiary is a family member of the current beneficiary). Under this scenario, it is unclear whether the 15-year requirement will “restart” upon a change in beneficiary or if the parent can immediately initiate the rollover of the 529 funds without incurring taxes and penalties.
