Close Close
ThinkAdvisor
529 plan piggy bank

Retirement Planning > Saving for Retirement > IRAs

Are 529 Plan Rollovers the New Backdoor Roth?

By John Manganaro

X
Your article was successfully shared with the contacts you provided.

What You Need to Know

  • Advisor and tax professionals see the new 529 account to Roth IRA rollover as one of the most appealing parts of the Secure 2.0 Act.
  • There is substantial disagreement about just how powerful a planning and inheritance tool these rollovers could be.
  • Experts say it is likely that Congress or the IRS will have to weigh in again to clarify key aspects of the rollover process.

The passage of the Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act in late December has sparked a debate in the retirement planning community about the potential to create “supercharged” 529 college savings accounts that could theoretically be used as highly tax-efficient vehicles for wealth transfers from individuals to their heirs or other beneficiaries.

The Secure 2.0 Act, which was included in the massive 2023 spending bill — thanks in no small part to an intense lobbying effort by retirement industry trade groups — boasts more than 100 distinct features that affect retirement planning. Among those getting the most attention is a new capability for the owners of 529 college savings accounts to roll unused money into a Roth IRA.

As Jeff Levine, Kitces.com’s lead financial planning nerd and Buckingham Wealth Partners’ chief planning officer, recently told ThinkAdvisor, the text of the Secure 2.0 Act appears to provide significant flexibility in the rollover process, with a limit of $35,000 “per beneficiary.”

Other retirement planning experts agree with that take, including Jamie Hopkins, managing partner of wealth solutions for Carson Group, who has called the 529-to-Roth rollover “one of the most interesting and potentially impactful features of the new law.”

As of mid-January, experts like Levine and Hopkins are dissecting and debating the new opportunity on Twitter, on financial planning podcasts and in firm-sponsored webinars, making the argument that the 529-to-Roth conversion pathway could amount to “the new backdoor Roth conversion.”

As such, they urge advisor professionals to study up on the new rollover opportunity — and to watch out for any proposed regulations from the IRS that could weaken or otherwise affect what appears to be a potentially powerful new planning approach.

Congressional Intent and IRS Regulations

As Levine, Hopkins and others point out, the 529-to-Roth conversion rule appears to be a rule with a “lifetime limit” that will apply “per beneficiary,” rather than “per account” or “per the converting taxpayer.”

So, it seems at first blush that an owner of a 529 account that held more than $35,000 in unneeded assets could theoretically change the beneficiary multiple times and then do a series of rollovers out of the 529 plan that would sum to an amount greater than $35,000.

According to Levine and Hopkins, it is not clear what Congress’ exact intent was in setting up this new rollover framework, and it is possible that lawmakers did not intend to create a loophole for total conversions in excess of $35,000. As such, they warn, lawmakers could very well issue a technical correction to more strictly apply the $35,000 lifetime limit, and the IRS is also empowered to set rules that could restrict the total amount of conversions.

“We will have to wait and see what kind of guidance might be issued,” Levine said on a recent webinar.

Whatever rollover amount is being considered, it is clear at this stage that the 529 account has to have existed for 15 years in order to qualify for this type of conversion.

Given this 15-year requirement, Levine and Hopkins argue, many clients should probably open a 529 plan today and put $50 or $100 in. That way they can get the 15-year clock started, even if they have to name themselves as the initial beneficiary.

A ‘Supercharged’ Opportunity?

Speaking recently with ThinkAdvisor, Ryan Losi, an executive vice president of the boutique certified public accounting firm PIASCIK, agreed that the 529-to-Roth IRA conversion represents one of the most exciting aspects of the Secure 2.0 Act.

While there are not millions of people overfunding 529 plans, this does give assurance to parents and grandparents who are saving for college, he said. With this new rollover pathway, the money can be repositioned for their children or grandchildren to become retirement savings, in cases where their 529 beneficiary goes to a cheaper school, gets a scholarship or does not attend college.

Before the adoption of Secure 2.0, families were penalized for withdrawing unused or leftover funds from their 529 accounts. Now, as Losi pointed out, families have an option other than simply withdrawing the funds and paying the excise taxes should their child decide against pursuing a higher degree — or complete their education without using all funds in the account.

“Depending on how the regulations shake out, I think this could be a very big deal for clients,” Losi said. “It appears that you will be able to supercharge the retirement savings of younger beneficiaries who don’t end up needing the money for education.”

As Losi explained, while a single beneficiary will only be able to inherit $35,000, this money will be sheltered within a Roth IRA and will have years, likely decades, to grow. And, the initial amount can be complemented by the younger account owner’s own future contributions or rollovers.

“I think we are likely to see regulations that aim to prevent abuses, but this will still represent a great opportunity for clients to create some tax diversification in their retirement wealth,” Losi said.

‘Devil Is in the Details’

While many advisor professionals are eagerly assessing the 529-to-Roth conversion, others are voicing a note of caution. For example, a new analysis published by Ian Berger, an attorney and IRA analyst with Ed Slott and Co., suggests the new rollover opportunity sounds more exciting than it is.

“We’re getting a lot of questions about the [Secure 2.0 Act] provision allowing tax-free rollovers from 529 plans to Roth IRAs,” Berger writes. “Although this new rollover opportunity sounds exciting, there are a number of restrictions that may limit its appeal.”

According to Berger, “as usual, the devil is in the details.” His reading of the law is that the $35,000 limit is indeed meant to be a lifetime maximum for a given 529 account owner, meaning they would not be able to distribute more than this amount by sequentially naming new beneficiaries. He expects this will be clarified by regulation or technical legislative correction.

“The 529 plan must have been open for more than 15 years,” Berger adds. “It is not clear whether a new 15-year waiting period is required when someone changes 529 beneficiaries or if the waiting period that applied to the prior beneficiary can be tacked on. We’ll need further clarification from Congress or the IRS.”

A further challenge, according to Berger, is that rollover amounts cannot include any 529 contributions or earnings on those contributions made in the preceding five-year period. And finally, rollovers are still subject to the annual Roth IRA contribution limit, meaning rollovers of sizable accounts will take years of coordinated planning.

“So, for example, if the Roth IRA contribution limit in 2024 remains $6,500, then no more than $6,500 can be rolled over from a 529 to a Roth IRA in 2024,” he writes. “Further, any actual Roth IRA (or traditional IRA) contributions made by the 529 beneficiary would count against the $6,500 limit. The effect of this rule is that a full $35,000 529-to-Roth IRA rollover would need to be done over several years. It also means that the 529 beneficiary doing the rollover must have compensation in that year at least equal to the amount being rolled over.”

He adds, however, that the income limits on Roth IRA contributions don’t apply.

(Photo: Shutterstock)

John Manganaro

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.