Episode Transcript
Brenton: [00:00:00] Over the past few weeks, you've seen articles telling you how it's now possible to roll unused funds from 529s into a Roth IRA account. In this episode, we tell you the details of this strategy and how likely you are to actually use it. Let's get started.
Hello, my name is Brenton Harrison of New Money, new Problems, and your host for the New Money New Problems podcast. In the last episode, we talked about the details of recently passed legislation called Secure 2.0, and we covered some of the four or five most relevant pieces of that regulation as it pertains to people with new money and new problems.
But there was a big part of that law or that rule that I left out because I wanted to give it its own episode, and that had to do with some things you're seeing in the news about transferring unused 529 dollars into a Roth retirement account.
I wanted to keep that separate because many of you may not be aware of how Roth IRAs work, of how 529s work, and if the strategy that you're [00:01:00] reading about is actually accurate or feasible for a lay person to enact.
But if you've been paying attention to the news or you have one of those article suggestion apps on your browser like I do, you're probably starting to see these articles all over the place.
From cnbc, families can make a tax-free rollover from 529 plans to Roth individual retirement accounts starting in 2024. From USA Today, stranded college savings plans can soon be rescued: new law lets 529 dollars roll into retirement. From money.com, save for college or retirement? New 529 rule makes it easier to help your kids do both. These are popping up all over the place and I would qualify these articles, if I can coin the term on this podcast, as a three quarters truth. A half truth is something that's told that leaves out a crucial part of the story with the intention to [00:02:00] deceive. This is not a half truth, I don't think the intention of these articles is to deceive, so I'm going to coin a three quarters truth as something that gives you almost all the accurate information you need, except whether it's likely for you to actually be able to put it in place.
How effective is this recommendation? That's a three quarters truth.
And this article detailing transferring unused 529 dollars definitely qualifies because as we'll share later in this episode, it is unlikely that a large number of people ever use this strategy, and even if they do, it likely won't be for their benefit, it may be for their kids' benefit.
In later episodes, we'll talk about how useful I think these tools are for people with new money and new problems, specifically to 529s. I have some unique thoughts on that matter, but that's not what this episode's for. Right now, we're just gonna talk about how these tools work Conceptually. To this point, we've covered some of the ins and outs of qualified retirement plans like a [00:03:00] 401k, and we've discussed some of those benefits. Mainly tax deferral, meaning that dollars that are put into a 401k or an IRA or a Roth IRA are not taxed as they increase in value.
And when you pay those taxes, it's based on whether you have what's called either a traditional or pre-tax retirement account or a Roth or post-tax retirement account. As an example, let's say you make a hundred thousand dollars for the year and you put aside $6,000 into a pre-tax retirement account.
Even though you made a hundred thousand dollars, your taxable income would decrease from a hundred thousand to $94,000. Now that money grows tax deferred, and if in your retirement years you take out $30,000 from that account in that year, your taxable income would increase by said $30,000.
It would look as if you earned it when it came time to pay your taxes.
With a Roth or post-tax account, you simply flip the [00:04:00] scenario on its head. If you make a hundred thousand dollars and you put $6,000 into a Roth retirement account, you still pay taxes on a hundred thousand dollars. The contribution is post taxes.
Now the money grows tax deferred, and if in that first year of retirement you take out $30,000, you do not pay income taxes on the 30,000, you have already paid income taxes on the front end. This is the difference between a pre-tax or traditional retirement account and a Roth account. Now let's cover 529 accounts. These are set up to facilitate and encourage people to set aside dollars for education savings.
A lot of people tie them to college savings, but it's not just college. You can use 'em for vocational school.
In some cases, you can use them for certified apprenticeship programs. It's not just college, but conceptually, these accounts allow you to put aside dollars and have them grow tax deferred, similar to a retirement plan. And similar to a Roth retirement account, you don't [00:05:00] owe taxes on the money that you withdraw as long as it's used to cover education costs.
Which aren't just tuition. It could be things like room and board. It could be things like a tablet or laptop that you need for school.
And when you see articles telling you these unused 529 s can now be repurposed into Roth IRAs, it almost wets your appetite and increases the attractiveness of a 529 as a savings tool.
But after the break, we tell you how likely or unlikely that is to occur and whether or not this is a strategy you can look forward to in your own finances.
Before the break. We talked about Roth retirement accounts 529 s and new legislation that potentially allows you to take unused 529 and transfer them into a Roth IRA.
But if you don't read the details of these articles, sharing these headlines, You might think you'll be able to take unused 529 s for your children's education and put them into your Roth retirement account, and that is extremely unlikely to occur [00:06:00] based on the details of what you have to have in place in order to make this transfer.
We'll put the links to all of the articles we covered at the beginning of this episode in the show notes, but one of those articles was from CNBC, and towards the end of the article you see a section called Limitations on 529 to IRA Transfers, and it tells you the restrictions associated with this new legislation.
So let's go through them in detail. The first of these being that there's a $35,000 lifetime cap on transfers.
This means that you cannot simply put aside $100,000, $200,000 into a 529 thinking, Hey, I'm covering the best of both worlds. If my child doesn't use it for college, I can simply repurpose it to my own retirement goals. That is not accurate. Even if you open five different 529 s that have a hundred thousand dollars each in them, you cannot take $35,000 from each account. It's $35,000 in total over the course of your lifetime.
Next. These rollovers are subject to [00:07:00] the annual Roth IRA contribution limit.
What this means is even though those contribution limits may change over time, you can't in one fell swoop transfer your $35,000. You have to do it in increments based on the contribution limits for that year. So this strategy will take a number of years to complete and it will take some intent to complete. You can't simply press a button for the transfer and be done with the transaction. Next, and this is a big one: the rollover can only be made to the beneficiary's Roth IRA, not that of the account owner. In other words, a 529 owned by a parent with the child as beneficiary would need to be rolled into the child's IRA, not the parents.
Now, let's take a pause there to talk about what this means when they're talking about beneficiaries and owners. A child under the age of 18 in this country cannot legally make decisions as to how money in their name is managed.
So the [00:08:00] law says that any money in their name has to be managed by an adult with legal standing. When 529 s are set up, you can pick the beneficiary of the account as your child. It means that this child is the person for whom these funds are intended, but they are not the account owner because they do not have legal standing.
So the child is the beneficiary, but the adult is the owner. The restriction on this IRA transfer is saying that if you move money from a 529 into a Roth retirement account, you cannot move it from the beneficiaries 529 into the owner's Roth IRA.
Essentially saying you can't move it from the child's college savings account to the parent's Roth retirement account. It has to go from the beneficiaries 529 to the beneficiary's Roth IRA. Meaning that if your child is that beneficiary, these funds can only be rolled into their retirement accounts, not yours, which immediately [00:09:00] points to why this is a three quarters truth; even though they didn't explicitly say that you could put this money into your retirement account, the title of these articles leads you to believe that you can. But in reality, that is not the case unless you decided to open up a 529 for your own education savings and then put it into your own Roth IRA. Unless that's the case, this is not something you'll be able to use for your own retirement.
Going back to our limitations , " the 529 account must have been open for at least 15 years, and it seems that changing account beneficiaries may restart the 15 year clock".
This means that you are limited in trying to do an end around to this strategy. Maybe you were thinking that you could open a 529 with your child as a beneficiary, but when it looks like they won't use the funds, you can simply name yourself beneficiary. That is not accurate because every time you change the beneficiary on the account, You have to wait a fresh [00:10:00] 15 years before you can use any of those dollars to transfer into a Roth IRA.
Again, reinforcing the fact that this is unlikely to be a strategy that you can use for your own funds.
And lastly, account holders can't roll over contributions or earnings on these contributions that are made in the last five years. So even if you are the beneficiary of your own account, even if you have had this account for at least 15 years, even if you did this from the beginning, intending to roll these unused dollars into your own Roth IRA, you still have to wait, and every five years you put money in, five years later will be the first time you can take that money out. Either the earnings or the contribution themselves.
All of this lets you know that the IRS is not opening up this allowance to let this be an if this, then that strategy. This is intended to truly incentivize people into putting money into the 529 accounts for [00:11:00] education savings. And if by chance, that doesn't allow them or their child to benefit from it in terms of paying for their schooling, then there are some limited circumstances where they can be repurposed for Roth retirement accounts. But will you be able to use it for your own Roth retirement accounts? Unlikely. Will you be able to use it to significantly impact your children's retirement accounts?
Maybe, depending on that child and how much you put aside in the 529. But now that you know what a three quarters truth is, at least in my mind, and as we continue to do these what's in the news segments, you can start to see why the titles of some of these articles that tell you what you can and can't do financially are not enough for you to take in and enact strategy.
You have to know the details of what's included in that article. You have to know how it applies to your situation. And you have to know, with guidance, in my opinion, whether or not it's something that should be pursued or whether it's something that's just a catchy article title that you should leave on the shelf.
Now we'll keep [00:12:00] bringing you these article titles and telling you about what you see online because some of them are strategies that you need to be aware of and can potentially put into practice.
But for now, I hope to shed some light into the limited feasibility of this news that you're seeing. I hope you enjoyed this episode. If you haven't already signed up for our email list at newmoneynewproblems.com/podcast so you can get more background information on what we're covering ,hear about upcoming trainings and just be a part of our community. And we'll be back with another episode next week.
